





































































Glass_ H£_Q_L__ 

Book .C 55" _ 

Copyright N ° r.cp 

COPYRIGHT DEPOSIT 





















HOW TO MAKE THE BEST USE OF THIS BOOK 


In this book we have attempted a new departure in the manner of pre¬ 
senting economic concepts. This has been done because the author feels, after 
many years of contact with the various texts on economics, that few if any 
of them are entirely satisfactory. The purpose of this book, however, is to 
supplement rather than displace other texts. 

It has been placed on the market at a price which makes it possible for 
the student to purchase it along with another standard text on economics. 
There is a marked tendency of students to purchase second-hand copies of 
books when they are available. Most of the standard works on economics are 
readily available in second-hand book stores. Since these things are so, a sug¬ 
gested plan of procedure is to encourage students to purchase one or more 
second-hand copies of other texts and study them in comparison with this 
one. By doing this two books can be had at the former price of one, and we 
feel that a better comprehension of economic concepts can be secured. 


/ 

THE EXPANSION 

OF 

ECONOMIC CONCEPTS 

BY 

FLOYD BARZILIA CLARK, ph.d. 

ti 

HEAD DEPARTMENT OF ECONOMICS 
AGRICULTURAL AND MECHANICAL 
COLLEGE OF TEXAS 


SOUTHWEST PRESS 

PUBLISHERS 


1 . 0 . 




DALLAS 


TEXAS 





Copyright 1932 
By SOUTHWEST PRESS 
Dallas, Texas 












SET UP AND PRINTED IN TEXAS 

©CU 51922 

'Mi 2? i332 / 







To All Serious Students 


of The Science of Economics 












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PREFACE 


In this study the author has undertaken to do in the main three things. 
The first of these is that of presenting economic concepts in perspective. 
This accounts for the title of the work, The Expansion of Economic 
Concepts. 

In most treatises economic concepts are presented in finality. If the 
authors were in full agreement there might not be reason for attempting 
a new departure in presenting economic concepts. But even then constructive 
attention to concepts as they exist might call for an analysis of how they 
came to be as they are. Then, too, the mere agreement among a group of 
scientists does not necessarily imply finality in their conclusions. The time 
when there was least disagreement among orthodox economists was the time 
when the science was in greatest jeopardy. That was the case at the time of 
the appearance of J. S. Mill’s Principles of Political Economy. In attempting 
to present economic concepts in perspective, therefore, the author has not 
only aimed at showing the major stages through which basic economic con¬ 
cepts have passed, but in a number of instances he has found it necessary 
to submit to critical analysis currently accepted concepts. 

The second objective is so far as practicable to correlate economic theory 
with perplexing problems. Economic theory would have little reason for 
existing if it could not be employed to throw light on practical problems. 
In his selection of these problems, the author has searched for types rather 
than for ones of passing interest. To this end we have inquired what light the 
theory of normal value throws on such a problem as the valuation of rail¬ 
roads. Likewise after giving our analysis of the economic theory of capital 
we raised the question of finding a more efficient plan »of creating capital, 
and treated that in the light of the consequences that might be expected. 
Tn a number of other places in the study we have not hesitated to consider 
the correlation of economic theory with practical economic problems. 

The third objective has been so far as possible to make the study retain 
the interest of the reader. The author is fully aware of the fact that to retain 
the lively interest of the reader is a difficult task when one digs deeply into 
economic concepts. We have, nevertheless, consciously made the attempt. 
We have, for instance, included a number of quotations presenting concepts 
which might as well have been stated in the language of the author. In this 


v 


VI 


PREFACE 


regard we have felt that the variety furnished by changes in style would 
add interest to the study. In other places we have employed terms and ex¬ 
pressions in the lighter vein. At all times we have attempted to visualize the 
forces with which we are dealing and think of them as living and vital 
forces. Our feeling is that if students of the subject of economics will always 
keep in mind the actualities of economic laws the subject can never fail to 
be interesting to them. 

We are hopeful that the inclusion of the portraits of a number of the 
leading authorities will add to the value of the work. In the selection of 
these portraits we have not confined ourselves to persons whose philosophy 
we endorse. Our selection has been rather of those characters who have made 
their influence felt in connection with the problem under study. A person’s 
philosophy may be of as great value as an object-lesson in the study of 
economic theory—as furnishing things to be avoided—as it is in giving ac¬ 
ceptable points of view. Economists, in the opinion of the author, are too 
much inclined to spurn a doctrine which they cannot accept simply because 
it does not happen to present matters as they see them. Our feeling about 
the whole subject is that few authorities in economics have fully compre¬ 
hended the subject-matter with which they are dealing. 

It has unfortunately been impossible to establish a sequence in the de¬ 
velopment of all of the concepts which we have included in our study. This 
has not been difficult to do for the concepts treated through Chapter VII, 
Part I. But beginning with Chapter VIII, Part I, and throughout Part II 
we have found it necessary to change somewhat our manner of treatment of 
the subject-matter. Upon close analysis, however, the reader will find that 
we have not departed from our central idea of so far as practicable pre¬ 
senting the concepts in perspective. Owing to the fact, however, that we 
have been unable to establish a sequence among the authorities, and owing 
to the further fact that many of the concepts there treated have apparently 
been slurred over somewhat by previous authorities, we have found it neces¬ 
sary to build some theoretical structures of our own. 

The whole subject of credit, for instance, is so far from satisfactory in its 
theoretical aspects in existing economic literature that we have found it 
necessary to break with almost every authority, and therefore build anew 
a theoretical structure for credit on the foundation laid by J. S. Mill. 

When we proceed with the development of the subject-matter of Volume 
II it will be necessary for us to do a similar thing. The subjects to be treated 
in the first part of Volume II have received solid attention by previous 
authorities. For each of the great subjects of rent, wages, interest, and profits 
there exists a most attractive sequence among the authorities in economics. 
To make our study a balanced whole, however, it is going to be necessary 
to include in Volume II subjects for which we are unable to establish a 


PREFACE 


VII 


sequence. We are hopeful that our feeble effort to handle them as we feel 
they should be handled will add something to the expansion of economic 
concepts. 

The study here made is largely the result of a number of years of teaching 
economics to students at the Agricultural and Mechanical College of Texas. 
The author wishes to take this means of expressing his gratitude for the 
inspiration and assistance rendered by each and every one of these students. 
He wishes further to acknowledge the valuable aid so willingly rendered in 
the preparation of the manuscript by his friend and associate, Professor 
W. H. Thomas, of the English Department of the Agricultural and Me¬ 
chanical College of Texas. 

Without drawing considerably on the work of other authorities a study 
of this kind would not be possible. We have had to balance one point of 
view against another again and again in order to sift out what appears to 
us to be the truth. We wish to acknowledge the kind consent of the pub¬ 
lishers of the works upon which we have drawn most heavily for the repro¬ 
duction of certain portions of those works. We desire especiallv to mention 
D. C. Heath and Company with whose permission we copied the biographical 
sketches of certain of the leading economists from Gide and Rist’s History of 
Economic Doctrines; the Century Company for the reproduction of a draw¬ 
ing showing the labor gradations from Fetter’s Principles of Economics; 
Harper and Brothers for the reproduction of a chart showing the changes 
in the price level from Edie’s Money, Bank Credit and Prices; Harcourt, 
Brace & Company for the reproduction of the chart showing the relation 
of the gold supply to the price level from Cassel’s A Theory of Social 
Economy; The Macmillan Company for the reproduction of a number of 
graphs from Marshall’s Principles of Economics. 


College Station, Texas. 
February, 1932. 


Floyd Barzilia Clark. 





I 


CONTENTS 


THE EXPANSION OF ECONOMIC CONCEPTS 

PART ONE— The Background 
CHAPTER I 

Page 

The Dominant and Contesting Theories of the Social Order 
Since 1756_ l _ 3 

CHAPTER II 

The Concept of Production _„_ 23 

1. Changing Definitions_ 23 

2. Ethical v. Economic Considerations_ 29 

3. Tests of Productive Activity_ 30 

4. The Surviving Confusion Analyzed_ 32 

CHAPTER III 

The Concept of Economic Laws ___ 41 

1. The Physiocratic Natural Order Concept_ 41 

2. Adam Smith’s Doctrine of Spontaneity_ 46 

3. Economic Laws as Scientific Laws_ 52 

(1) The Later Classical Concept_ 52 

(2) The Effort of the Historical School to Reconstruct the 

Science of Economics in Conformity with the Inductive 
Method _ 5 4 

(3) Karl Menger’s Defense of Classical Economics_ 56 

(4) Economics as a Science_ 5 8 

CHAPTER IV 

Market Value- 63 

1. Preliminary Comment - 63 

2. The Physiocratic "bon prix”- 64 

3. Adam Smith’s Equilibrium of Demand and Supply--- 66 

4. Refinement of Equilibrium Concept- 67 

(1) Mill’s Effort to Clarify--- 67 


IX 
























X 


CONTENTS 


Page - 

(2) Marginalism _ 69 

(3) Definition of a Market__ 70 

(4) Supply and Demand Schedules_ 71 

CHAPTER V 

Normal Value _______ 8 7 

1. The Physiocrats had a Doctrine of Normal Value_ 87 

2. Adam Smith’s Failure to Choose between Labor and Cost of Pro¬ 

duction as Controlling Normal Value_-_ 88 

3. Ricardo and the Labor Theory of Value____ 88 

4. Post Ricardian Concepts of Normal Value_ 92 

(1) Mill and Normal Value_ 92 

(2) Bastiat and the Service Value Concept_ 92 

(3) Neo-Classical Economics and Normal Value_ 93 

CHAPTER VI 

Correlation of Value and Price_____„_ 109' 

1. Subdivisions of the Value Concept_ 109 

2. Fundamental Definitions _ 109 

(1) Goods _.1___ 110 

(2) Utility _:_ 110 

(3) The Whole Supply v. a Particular Quantity_ 111 

(4) Value in Use_ 111 

( 5 ) Diminishing Utility_ 111 

(6) Marginal Utility _ 112 

3. Refinement of the Concept of Utility_ 113 

CHAPTER VII 

Prices__ 117 

1. Definitions of Price_ 117 

2. Price Analysis_ 119 

(1) Competitive v. Monopoly Price_ 119 

(2) Monopoly Price Analyzed_ 120 

(3) Competitive Price Analyzed_ 123 

CHAPTER VIII 

Business Men’s Reactions to the Law of Competitive Price_ 13 5 

1. Different Commodities have Different Ways of Finding their 

Market _ 135 

2. The Organized Exchanges___ 13 5 

3. Commodities not Adapted to Organized Exchanges_ 140 



















































CONTENTS 


xi 


Page 


4. Details of Government Assistance in Marketing_ 146 

5. Competitive Prices and Economic Progress_ 148 

6. Enterprises which Thrive on Price Changes_ 149 

CHAPTER IX 

^Business Crises ___ _____ _ 157 

1. Characteristics of the Business Crisis_ 157 

(1) The General Business Crisis_ 15 8 

(2) The Special Business Crisis__ 15 8 

2. The Relation of the General Crisis to the Price Level_ 159 

3. Theories of Business Crises-.._>„___ 160 

(1) J. B. Say and Theory of Unbalanced Production;_ 160 

(2) Sismondi and the Under-Consumption Thesis_ 161 

(3) Sismondi’s Thesis Amplified___ 163 


a. The Saint Simonian Thesis. 

b. Robert Owen and the Labor Coupon Scheme. 

c. Karal Rodbertus and Industrial Planning. 

d. Current Revivals of the Under-Consumption Thesis. 

(4) Professional Economists’ Analyses of Business Crises__ 170 

a. Deductive Analyses. 

—J. S. Mill. 

—The Neo-Classicals. 

b. Inductive Analyses. 

—The Marxian Thesis. 

—The Mitchell Thesis. 

—The Cassel Thesis. 

A. Conclusion _...__— 184 


CHAPTER X 

Money_..._,_..._ 189 

1. Definition of Money_—- 189 

2. Brief History of Money_1-—~ 191 

3. The Functions of Money---—- 194 

(1) Private Functions. 

(2) Social Functions. 

4. Money and Value_____ 199 

(1) Prices and the Value of Money. 

(2) Unfortunate Influences of the Changes in the Value of 

Money. 

(3) Measuring Price Changes. 

(4) Efforts to Discover a More Perfect Measure of Value. 

(5) The Quantity Theory of Money. 
























Xll 


CONTENTS 


Page 

5. Conclusion _________ 220 

CHAPTER XI 

Credit _....___ 22 5 

1. Characteristics of Credit_ 226 

(1) Is Futurity Essential to Credit? 

(2) Credit v. Capital 

(3) The Credit Circle. 

2. Definition of Credit _ 229 

(1) What a Definition Must Show. 

(2) The Inaccuracy of Most Definitions. 

(3) A Working Definition of Credit. 

3. Classes of Credit_ 229 

(1) According to Uses. 

(2) According to Duration. 

4. Credit Institutions _ 23 5 

(1) Purpose of. 

(2) Types of. 

5. The Relation of Credit to Value_ 260 

PART TWO —The Economics of Production 
CHAPTER I 

Social Interest as Contrasted with Private Interest_ 267 

1. Wealth v. Value_ 267 

2. Difficulty of Measurement of Consumer Interest_..._ 269 

3. Fostering Care of Producer Interest_ 273 

4. Consumer Interest not Well Protected_ 274 

CHAPTER II 

Land and Other Natural Agents_ 279 

1. Land as an Agent of Production_ 280 

2. Other Natural Agents_ 282 

3. The Law of Diminishing Returns _ 283 

4. Ownership of Natural Agents_ 290 

(1) Agricultural Lands. 

—Transition to Private Ownership. 

—The United States Land Policy.' 

—Virtues and Defects of Private Ownership of Agri¬ 
cultural Lands. 

(2) Forests. 






















CONTENTS 


Xlll 


Page 


(3) Urban Lands. 

(4) Subsurface Rights. 

(5) WaterPower. 

(6) Radio Waves. 

5. Knowledge of the Phenomenon of Rent Essential to a Comprehen¬ 
sion of the Land Problem_ 290 

CHAPTER III 

Labor in the Productive Process___ .... 303 

1. Labor Defined _____:_T._ 304 

2. Division of Labor._ 306 

3. The Laws of Labor___ 308 

4. Historical Changes in the Laborers’ Status_ 312 


(1) Emergence from Slavery. 

(2) Emergence from Feudalism. 

(3) Contract Labor. 


5. Labor Gradations_ 31 S' 

6. Labor Problems _320 

(1) Unemployment. 

(2) Wages. 

(3) Child Labor. 

(4) Hours of Work. 

(5) Social Insurance. 


7. The Rise of the Laborers to the Consciousness of their Own 


Strength __ 327 

CHAPTER IV 

Capital as a Factor in Production_ 33* 

1. The Term Capital___ 3 3 3> 

2. Capital Values v. Capital Goods_-_ 333 

3. Lucrative v. Productive Capital_ 334 

4. Capitalistic Production _,--- 33* 

(1) Indirectness v. Timeliness. 

(2) The Growth of Capitalistic Production. 

5. The Economic Theory of Capital- 337 

(1) Mill’s Fundamental Principles. 


(2) Capital Distinguished from Land and Other Natural Age its. 

(3) Not Two Distinctions but Six. 

(4) How Capital is Formed. 

6. The Cost of Capital and the Doctrine of Surplus Value - 35* 




















XIV 


CONTENTS 


Page 

7. Capital Classified ___ 35 5 

(1) Fixed v. Variable. 

(2) Specialized v. Mobile. 

CHAPTER V 

The Possibility of a More Efficient System of Creating 

Capital ___ 3 59 

1. Statement of the Problem_._3 59 

(1) The Supply and Demand of Lucrative Capital. 

(2) The Supply and Demand of Concrete Capital Goods. 

2. A More Efficient System of Creating Lucrative Capital_ 361 

(1) A Problem in Compound Interest. 

(2) Forces which Tend to Neutralize the Effects of Accumu¬ 

lating Loanable Funds. 

(3) Theoretical Consequences of the Change. 

3. A More Efficient System of Creating Concrete Capital Goods_ 361 

(1) Where We Are Headed. 

(2) Forces Tending to Obstruct the Advance. 

CHAPTER VI 

The Entrepreneur (Enterpriser) ___377 

1. What Term to Employ_.___ 377. 

2. The Function Itself_*_ 378 

(1) The Entrepreneur Function and the Social Order. 

3. The Definition of the Entrepreneur_ 3 80 

4. Naming the Entrepreneur’s Share_ 3 83 

(1) History of the Term Profits. 

(2) A New Term Suggested. 

5. The Size of the Residuum____3 85 

(1) Seldom Found in its Pure State. 

(2) The Pure Residuum Illustrated. 

6. The Entrepreneur Function and the Business Form_ 3 88 






















LIST OF ILLUSTRATIONS 

Page 

Quesnay _1_ 1 

Malthus _ 39 

Marshall --— 8 5 

Mill _ 107 

Rodbertus _ 133 

Chicago Board of Trade_137-9 

Sismondi ___ 15 5 

Proudhon - 223 

Fourier_ 301 

Say_-_-_ 375 


xv 

















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PART ONE 


THE BACKGROUND 








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2 


THE EXPANSION OF ECONOMIC CONCEPTS 


D. Francois Quesnay 


" 'The genuine economists [Physiocrats] are easily depicted. In Dr. Quesnay they have 
a common master; a common doctrine in the Philosophic rurale and the Analyse economique. 
Their classical literature is summed up in the generic term Physiocracy. In the Tableau 
economique they possess a formula with technical terms as precise as old Chinese characters.’ 
This definition of the Physiocrats, given by one of themselves, the Abbe Baudeau ( Ephemerides, 
April, 1776)—writing, we may be sure, in no malicious spirit—shows that the school pos¬ 
sessed not a little of the dogmatism of the Chinee. 

"The first not only in chronological order but the chief recognized by all was Dr. Ques¬ 
nay (1694-1774), the physician of Louis XV and of Mme. de Pompadour. He had already pub¬ 
lished numerous works on medicine, especially the Essai physique sur PEconomic animate 
(1736) before turning his attention to economic questions, and more especially to problems of 
'rural economy.’ His first contributions, the essays on Les Grains and Les Fermiers, which ap¬ 
peared in the Grande Encyclopedic in 175 6 and 1757, were followed by his famous Tableau 
Economique in 1758, when he was sixty-four years of age, and in 1760, by his Maximes 
generates du Government economique d’un Royaume agricole, which is merely a development of 
the preceding work. 

"His writings were not numerous, but his influence, like that of Socrates, disseminated 
as it was by his disciples, became very considerable. 

''The best edition of his works is that published by Professor Oncken of Berne, OEuvres 
economiques et philosophiques de F. Quesnay (Paris and Frankfort, 1888).”—Gide and Rist: 
History of Economic Doctrines, p. 3, note. 


CHAPTER I. 


THE DOMINANT AND CONTESTING THEORIES OF THE 
SOCIAL ORDER SINCE 1756 

Fortunately for us we do not live in a society that considers itself in¬ 
violate. It is not too much to say that the greatness of the modern era centers 
around that one fact. If we can demonstrate that there are defects in our 
social order, all that is needed is leadership enough, vision enough, and courage 
enough to supply the remedy. If the defect can be proved to be beyond 
repair, and the institution or institutions as they exist are sapping the life 
out of the people, then it lies within our power—in fact it is our duty— 
to abandon the institution or institutions and substitute something better. 

There have always been dominant and contesting theories. But in most 
periods of history the contesting theories have had small chance of expression. 
Since 1756, in much of Europe and in America, that has not been true. It 
is this fact that makes the subject of the dominant and the contesting 
theories of the social order since 1756 of such interest. During this period, 
the persons whom we call the social scientists have dared to examine social 
institutions with the same degree of calmness as a doctor examines his patient, 
or as a physicist examines a ray. 

MERCANTILISM AS A DOMINANT THEORY IN 1756 

The term Mercantilism has become so widely employed that little needs 
to be said in defence of its use to describe the dominant theory of the social 
order during the several centuries preceding 1756. 

The outstanding features of Mercantilism are: 

(1) There was no school of Mercantilists in the same sense as we speak 
of the Classical School of economists. The philosophy was simply that of 
statesmen and writers with regard to national wealth. The principles were 
simply accepted almost universally by persons who thought seriously on the 
problem of production and of national welfare. 

(2) A few of the accepted principles were: (a) Wealth is synonymous 
with gold and silver. Hence a nation to be wealthy must take care that its 
supply of the precious metals is conserved and built up. Those nations which 
had gold mines were already wealthy. Those nations which did not have 

3 


4 


THE EXPANSION OF ECONOMIC CONCEPTS 


gold mines had to study methods of stimulating the flow of gold to their 
boundaries, (b) The major productive activity, therefore, was trading with 
other nations. In fact it was not thought that business activity at home 
was productive since there was no increase in substance. The feeling was 
that only by means of foreign trade could the stock of goods be increased, 
and by that means only if more goods were brought in than were taken away. 
They were sure that if a nation sold more goods than it bought its supply of 
the precious metals was conserved. 

Growing out of this balance of trade doctrine there developed in all of 
the principal nations of Europe an expansive and minute system of govern¬ 
mental interference with private enterprise. It would take too long even 
to mention the names of well-known statutes which were prompted by the 
Mercantilist doctrines. Those of England concerning the American colonies 
are the best known. England’s policy of attempting to force her colonies to 
produce only raw material to be shipped into England there to be manufac¬ 
tured and possibly exported was a direct consequence of the dominance of 
the Mercantilistic doctrines in the minds of the English statesmen. If Adam 
Smith had written his Wealth of Nations twenty-five years earlier, and if 
it could have had the same influence on English statesmen from 1750 to 1775 
as it did have from 1776 to 1800 the American Revolution might not have 
occurred. 

The curtain rises on the period of our study just as a number of great 
thinkers were beginning to challenge Mercantilism. The success of the 
American colonies did much to jar the English statesmen into the conscious¬ 
ness of the unsoundness of their philosophy; but twenty-five years before the 
revolt of these colonies the doctrines of Mercantilism were being contested 
powerfully in France. Reference is, of course, to the Physiocrats. 

THEORIES CONTESTING MERCANTILISM 

(1) The Physiocrats .—The exponents of the Physiocratic philosophy were 
completely out of harmony with the Mercantilists. They in fact denied that 
foreign trade had the faculty of increasing national wealth at all, referring 
to it as pis alter (dry teat). They, therefore, set out to explain and give a 
scientific demonstration of the exact nature of production, and other aspects 
of the creation and distribution of wealth. It was in connection with their 
effort to do this that we had the foundation laid for the science of economics. 

The Physiocrats were particularly desirous of saving France from the 
great catastrophe which they must have known to be inevitable. Those of 
us who view the situation now can see that in all likelihood if the King 
had taken the Physiocrats at their word and had instituted the reforms 
exactly as they recommended, this action might have saved France from the 
Revolution. The Physiocratic system is interesting to us, nevertheless, because 


DOMINANT AND CONTESTING THEORIES SINCE 1756 5 


it stands as one of the major contestants of Mercantilism. We are, therefore, 
at this time, interested only in that portion of the Physiocratic system that 
deals with the nature of production and the analysis of the natural order. 
In their answer to the question of what is production they were aiming 
directly at the economic philosophy of the statesmen of the day—the Mer¬ 
cantilists. In their explanation of the natural order they were attempting to 
show the unsoundness of the minute governmental interference with private 
business. 

At a later point in this study it will be necessary for us to examine more 
critically the Physiocratic concept of production. Suffice it to say here that 
it is not always correctly understood. The fact is the Physiocrats developed 
a remarkably accurate explanation of the social order in which they lived. 
It is somewhat hard to say how much of their teaching was intended merely 
as flattery to the landed proprietors and how much they actually believed. 

Their concept of production was exactly the reverse of that of the 
Mercantilists. With them agriculture alone was productive; with the Mercan¬ 
tilists international trade alone was productive. With the Physiocrats the 
wealth of a nation increased and decreased with what they called the net 
product —the raw materials. They worked out an attractive scheme of dis¬ 
tribution called by them the tableau economique. The point of emphasis in 
the tableau economique was that the peasants got merely enough to keep 
them alive, likewise the artisans and traders, whereas the landed proprietors— 
the gentry—drew the net product—that amount resulting from agriculture 
in excess of that necessary to keep the farmers alive and in business. The net 
product came from the farmers but went to the proprietors—the leisure 
class. It is readily seen, therefore, that when we state that the Physiocrats 
believed that agriculture alone was productive we tell only a half truth. In 
accordance with the same line of reasoning, if they were writing today they 
would teach that the big business men alone are productive. But their teach¬ 
ing was directly counter to Mercantilism and nearer the truth. 

In connection with the Physiocratic concept of the natural order we 
have their most characteristic philosophy of the social order. With them the 
minute governmental regulations of the Mercantilists were from the bottom 
up out of harmony with what they considered the ideal social order. As a 
substitute for the aggressive and determined governmental sponsorship of 
national wealth they substituted the expression laissez faire, laissez passer, 
one of the most famous phrases of all history, and perhaps embodying the 
most dynamic philosophy underlying the social order the world has ever ex¬ 
perienced. 

Care should be exercised, however, in examining the Physiocratic concept 
of laissez faire. We are likely to think that wherever the expression is found 
among the so-called classical economists it means the same thing. The Physio- 


6 


THE EXPANSION OF ECONOMIC CONCEPTS 


cratic concept of laissez faire was vitally different from that held by Adam 
Smith, although the objective was the same, namely, the substitution of a 
higher theory of the social order in the place of Mercantilism. 

The Physiocratic concept was briefly that there exist natural laws which 
control human behavior. If the agencies of social control are brought into 
conformity with the Divinely-provided natural order society flourishes. If 
the natural laws are violated, affairs do not go so well. They, furthermore, 
thought that the laws were to be discovered and that it was the duty of 
the king to adapt his own behavior and that of his subordinates to these laws. 
It was of small importance to the Physiocrats whether or not the government 
were a monarchy or some other form so long as the policy o i laissez faire 
was followed—that of avoidance of interference with the natural order. 
They believed, however, that the monarchy was well adapted to the purpose, 
if the monarch could once be brought to see that his position is more like 
that of a band master than an overseer of slaves. As we shall see presently, 
Adam Smith’s concept was that of spontaneity of economic institutions— 
an entirely different interpretation of laissez faire. The Physiocrats thought 
of themselves as the instructors in the principles of the natural order. It was 
in connection with their effort to discover the principles of the natural order 
that they laid the foundation for the science of economics. 

(2) Adam Smith’s Doctrine of Spontaneity. —Although the Physiocratic 
concept of the natural order is fascinating, it does not appear to be the one 
that did the most to overthrow the Mercantilist domination. After Adam 
Smith’s Wealth of Nations was published in 1776, for something like seventy- 
five years his dogma became the basis for all authoritative works on eco¬ 
nomics. Even though, therefore, the Smith concept of spontaneity is not as 
nearly the modern concept of economic laws as was the Physiocratic concept 
of the natural order, yet it was the Smith concept that made the laissez faire 
doctrine such a dynamic one. 

According to the Smith concept laissez faire would be translated "hands 
off” whereas "let go” would be about the correct interpretation in the eyes 
of the Physiocrats. With Smith, there tended to develop within the social 
order forces that would themselves work out to the best interest of all if 
the government would cease to regulate private affairs. His whole thesis 
centered around the principle that self-interest is in conformity with social 
interest. If the government kept away, self-interest would spontaneously 
assert itself and each individual in following his own interest would involun¬ 
tarily foster the interest of society. Out of this philosophy developed his 
doctrine of competition as the regulative force. In it we find the inspiration 
of the competitive order with all of its concomitants—some of the principal 
concomitants being (1) the inviolability of private contracts, (2) the wage 
system, (3) unregulated prices, etc. 


DOMINANT AND CONTESTING THEORIES SINCE 1756 7 


If any book is to have the credit of destroying Mercantilism as the 
dominant philosophy of the social order, Adam Smith’s Wealth of Nations 
is that book. And that was its prime objective. If therefore the Mercantilist 
answer to the question of national wealth was erroneous what then was the 
correct answer? Smith set his hand to that problem and gave a much more 
satisfactory answer to it than did the Physiocrats. 

Needless to say he found the Physiocratic doctrine too narrow. Gold was 
not synonmous with wealth as taught by the Mercantilists, nor was agri¬ 
culture alone productive. The term wealth was enlarged to include all want- 
satisfying goods and the term production was expanded in its meaning. 

Smith’s answers to these questions are not held by present-day economists, 
but they were by far the best that had thus far been given, and they served 
as good working substitutes for the Mercantilist concepts which were being 
abandoned. 

THE RISE OF LAISSEZ FAIRE TO DOMINANCE 

It would be erroneous to say that laissez faire completely destroyed 
Mercantilism. In fact there are survivals of Mercantilism even until now. 
It has been said that a theory will live long after it has been abandoned by 
the best thinkers. Adam Smith certainly knocked the brains out of Mercantil¬ 
ism and as much of it as survives today lives because of this peculiar vitality 
of a theory. 

"The first thirty years of the nineteenth century witnessed profound transformations in 
the structure of the economic world. 

"Economic Liberalism had everywhere become triumphant. In France the corporation era 
was definitely at an end by 1791. Some manufacturers, it is true, demanded its re-establish¬ 
ment under the First Empire; but they were disappointed, and their demands were never re¬ 
echoed. In England the last trace of the Statute of Apprentices, that shattered monument of 
the Parliamentary regime, was removed from the Statute Book in 1814. Nothing remained 
which could possibly check the advent of laissez-faire. Free competition became universal. The 
State renounced all rights of interference either with the organization of production or the 
relations between masters and men, save always the right of prohibiting combinations in 
restraint of trade, and this restriction was upheld with a view ta giving free play to the law 
of demand and supply. In France the Penal Code of the Empire proved as tyrannous as the 
old regime or the Revolution; and although freedom of combination was granted in England 
by an act of 182 5, the defined limits were so narrow that the privilege proved quite illusory. 
The general opinion of the English legislator is well expressed in the report of a commission 
appointed by the House of Commons in 1810, quoted by Mr. and Mrs. Webb. 'No interference 
of the legislature with the freedom of trade, or with perfect liberty of every individual to 
dispose of his time and of his labour in the way and on the terms which he may judge most 
conducive to his own interest, can take place without violating general principles of the first 
importance to the prosperity and happiness of the community.’ In both countries—in England 
as well as France— a regime of individual contract was introduced into industry, and no legal 
intervention was allowed to limit this liberty—a liberty, however, which really existed only 
on the side of the employers.’’—Gide and Rist, History of Economic Doctrines, p. 170. 

The whole social atmosphere was permeated with the same note. The 
tentacles of laissez faire have become so embedded in our court decisions that 
they remain, in many instances, serious obstacles to constructive social legis¬ 
lation. Even architecture, and other forms of art, show the marks of this 


8 


THE EXPANSION OF ECONOMIC CONCEPTS 


individualism which had its basis in laissez faire. The poetry of Shelley, 
Byron, and Burns certainly give a beautiful spiritualization of the same 
dominant note. 

THEORIES CONTESTING THE LAISSEZ FAIRE DOCTRINE 

No sooner had the competitive order displaced Mercantilism than there 
began to appear knocks in the machinery. The smoothness of the adaptation 
of the different social forces one to another as pictured by Adam Smith and 
his followers was not apparent. The principal hitches in the system were, 
in the order of their importance, (1) the congestion of population in the 
cities, (2) intolerable working conditions in the factories and mines, and 
(3) financial or business crises. 

The economists viewed these conditions without alarm and explained 
that affairs in the long run would adjust themselves. But conditions of the 
kind stirred a number of powerful personalities to attack what had come 
to be called now the established order. I have classified these contestants into 
four groups: (1) Compromising Classical Economists, (2) Socialists, (3) 
Anarchists, and (4) the Historical School of Economists. 

The Compromising Classical Economists. —In employing the term com¬ 
promising economists the writer is thinking of those persons who although 
not opposed to the teachings of the economists—in fact they accepted the 
conclusions of the economists—were not willing to accept the consequences 
of unrestrained competition. The warmest-hearted of these was Jean Charles 
Sismondi (1773-1842). 

Sismondi is famous for the origination of the under-consumption theory 
of business crises. He was stirred by the suffering and want which he wit¬ 
nessed resulting from business crises. He attributed the cause of these crises 
to the fact that wages, under the new order, did not increase rapidly enough 
for the consumers to sustain the market for the goods produced. He wanted 
the government to assert itself in behalf of the unfortunate members of 
society who were victims of the competitive order. 

Another compromising economist was Friedrich List. List’s attack was 
hurled directly against the laissez faire policy. He would have restored a sort 
of glorified Mercantilism. He, in fact, admitted that he was a Mercantilist. 
He claimed that the whole of classical economics was constructed on one 
of the Mercantilist concepts—that of buying in the cheapest and selling in 
the dearest market. To the end sought by List he wished to substitute 
national possibilities of production for national wealth. 

"But what are these productive forces which constitute the permanent source of a nation’s 
prosperity and the condition of its progress? 

"With particular insistence List first of all mentions the moral and political institutions, 
freedom of thought, freedom of conscience, liberty of the press, trial by jury, publicity of 
justice, control of administration, and parliamentary government. All of these have a stimu- 


DOMINANT AND CONTESTING THEORIES SINCE 1756 9 


lating and salutary effect upon labour. He is never weary of recalling to mind the loss of 
wealth caused by the Revocation of the Edict of Nantes, or by the Spanish Inquisition, which, 
he says, 'had passed a sentence of death upon the Spanish navy long ere the English and 
Dutch fleets had executed the decree’ (p. 88). He unjustly accuses Smith and his school of 
materialism, and condemns them for neglecting to reckon those infinitely powerful but per¬ 
haps less calculable forces.”—Gide and Rist, p. 273. 

At this point in our discussion List is interesting to us because he was 
a powerful contestant of the laissez faire system. Under his counsel a policy 
of broad and constructive nationalism would have been substituted for 
laissez faire. 

The Socialists .—The most uncompromising contestants of the established 
order, as it had come to be called by them, were the Socialists. There were 
so many groups of these that a comprehension of them is possible only by 
dividing them into classes. 

(a) The socializing Socialists were inspired by Saint Simon and his fol¬ 
lowers. Their controlling motive was the reform of society by means of its 
institutions, i. e., the substitution of a new set of governmental institutions 
for the old,, The new institutions were to be so constituted that the evils of 
the established order would no longer exist. Saint Simon desired to abolish 
the professional politician and create a government by technicians and busi¬ 
ness men. He founded a new religion and attempted to extend his teaching 
through that medium. Saint Simon is especially noted for the fact that he 
was the inspiration of August Comte, and thus correctly thought of as the 
originator of sociology. 

The immediate followers of Saint Simon departed from his teaching 
somewhat. They are especially noted for the fact that they made the first 
attack on the right of private property. 

(b) The associative Socialists differed from the Saint Simonians in that 
their effort was to separate themselves from society as they knew it and start 
over. The two noted exponents were Robert Owen and Charles Fourier. 
Owen, being a man of wealth, was able to sponsor, with his own money a 
number of experiments, one of which was in the United States. The central 
theme of Owen was that the cause of poverty was profits. The fact of 
profits, according to him, was traceable to money. He thought that if the 
proper opportunity were afforded, goods would exchange for goods on the 
basis of the number of hours of labor expended in their production. All of 
the experiments sponsored by Owen failed, but his theory of the abolition 
of profits bore fruit in the inception and growth of consumers’ cooperation. 
Consumers’ cooperative societies have had a steady growth since his day. 
If there is ever an effective substitute for the competitive system extensively 
developed, the consumers cooperative organization holds the best chance of 
becoming that substitute. 

Fourier was a dreamer without the resources to try out his experiments. 


10 


THE EXPANSION OF ECONOMIC CONCEPTS 


His leading doctrine has taken form in the statement of a law relating to 
the irksomeness of labor. The law is stated as follows: The irksomeness of 
labor varies directly with constraint and inversely with freedom. The most 
painful of all labor is slave labor. The most delightful of all labor is that 
which one performs of his own volition. These facts are but evidences of 
the truthfulness of the law of labor. Fourier thought, therefore, if social 
groups could be organized without the presence of constraint all labor would 
be performed by those who found delight in it. Consequently, Fourier desired 
to sponsor a back-to-the-country movement, in settlements of about four 
hundred families each. These settlements were to be established in accordance 
with his delightful plan of productive behavior. 

His solutions to the problem of distribution in these colonies were unique. 
Except for the fact of absence of constraint with regard to tasks performed, 
there was little if any room for the operation of the principle of laissez faire. 
The organization was to proceed as outlined in his books. These principles 
were to be the guides instead of a policy of laissez faire. 

(c) The Christian Socialists.—There were three classes of the Christian 
Socialists, viz., the Catholics, the Protestants, and the Mystics. Since there is 
little substantial economic philosophy in the teaching of either of the first 
two, only a brief mention need be made of them. Their general point of 
attack was that the church has been giving too much emphasis to life after 
death, and has been neglecting life here on earth. Their effort was, therefore, 
to correct this defect, with the hope that the materialists would return and 
find comfort in the church. Both the Protestants and the Catholics sought 
the solution of the problem of social reorganization through the means of 
producers’ cooperation. They differed, of course, with regard to the relation 
of the associations to the religious organizations. But the general import was 
very similar. Probably the chief result of their teaching is the institutional 
church, an organization which really, though in a very small way, offers a 
solution to the social problem. 

The teaching of Le Play, although he cannot logically be associated spe¬ 
cifically with either the Catholic or Protestant group, carries a very appealing 
note. His emphasis is on the importance of the preservation of the family. He 
finds that there are three types of families: (1) the patriarchal, (2) the 
family group, and (3) the unstable family. The present order is characterized 
by the third, whereas either of the other two would be superior to it. The 
second—the family group—is Le Play’s choice, for "it holds the balance evenly 
between the two antagonistic forces which are both indispensable to society, 
namely, the spirit of conservatism and the spirit of innovation. Under the 
patriarchal family the former predominates, and under the unstable family 
regime it is utterly wanting”. Le Play would have it so that all of the chil¬ 
dren could go out in the world and attempt to make their way except one. 


DOMINANT AND CONTESTING THEORIES SINCE 1756 11 


This one should remain the father’s associate during the latter’s lifetime. At 
his death the son remaining at home would become the head of the family. 
The homestead would thus always be kept intact. Those who had failed in 
their effort to make their way might at least have a place to go till they could 
recover their foothold. 

(d) Ruskin, Carlyle, and Tolstoi are classified as the mystics. The first 
and last of these were particularly interested in the modification of the social 
order. Carlyle is best thought of as a satirist directing his caustic comments 
against the classical economists. He is almost without question the greatest 
enemy that the classical economists encountered. 

It was Carlyle who dubbed economics the "dismal science”. The following 
quotation from "Chartism” explains the phrase: 

“It [Political Economy] sounds with Philosophico-Politico-Economic plummet the deep 
dark sea of troubles, and having taught us rightly what an infinite sea of troubles it is sums 
it all up with the practical inference and use of consolation that nothing whatever can be done 
about it by man, who has simply to sit still and look wistfully to time and general laws, and 
thereupon without so much as recommending suicide coldly takes leave of us.” (Quoted in 
Gide and Rist, p. 511, note). 

Again in '•‘Past and Present”, referring to the problem of unemployment: “If thou ask 
again .... what is to be done? allow me to reply; By thee, for the present almost nothing 
.... Thou shalt descend into thy inner man and see if there be any traces of a soul there; 
till then there can be nothing done! .... Then shall we discern, not one thing, but, in 
clearer or dimmer sequence, a whole host of things that can be done. Do the first of these.”— 
Gide and Rist, p. 511, note. 

Of all the writers on economic subjects inspired by Christianity, Ruskin 
considered himself the most profound; in the introduction to his ^Munera 
Pulveris” (1862) he wrote: "The following pages contain, I believe, the first 
accurate analysis of the laws of Political Economy which have been published 
in England.” 

Ruskin summarized his program of social regeneration under six heads: 

1. Compulsory manual labor for everybody. 

2. Work should be provided for everyone. "There would be no problem 
of unemployment if everybody would do something.” 

3. Compensation should be fixed by custom instead of by competition. 

4. Lands, mines, and waterfalls, should be nationalized. 

5. There should be a social hierarchy graded according to the character 
of the work to be done. 

7. Education should be compulsory. 

It takes very little knowledge of the fundamentals of economics to ap¬ 
preciate the fact that the high-minded men were scoffing at something thai 
they understood very poorly. Only the fourth and last of Ruskin’s program 
have anything worthy of serious consideration. 

(e) The State Socialists.—Unless it be the Fabians, no group of Socialists 
has had as good an appreciation of the science of economics as the State 
Socialists. The objective of these, however, is not materially different from 



12 


THE EXPANSION OF ECONOMIC CONCEPTS 


that of other Socialists, but their method is different. They arrive at the 
same place but by a different route. The State Socialists aim finally to bring 
all industry under the control of the government by the extension of gov¬ 
ernmental activities. In their philosophy, however, there is a much more 
dignified and refined note than is evident in other Socialist groups. 

An outstanding forerunner of the State Socialists was Karl Rodbertus. 
Although the inspirer of State Socialism and in fact a State Socialist at heart, 
Rodbertus himself refused to admit that he was in sympathy with their 
program. He called them "sweetened water thinkers.” Rodbertus’ compre¬ 
hension of economics is seen in his recognition of the virtues of the division 
of labor, and in his concept of effective demand. He broke with Classical 
economists on their concept of spontaneity. "No state,” say he, "is sufficiently 
lucky or perhaps unfortunate enough to have the natural needs of the com¬ 
munity satisfied by natural law without any conscious effort on the part of 
anyone.” He, therefore, wished to substitute a conscious plan of production 
and distribution which would eliminate the maladjustments characteristic 
of the competitive system. He would do this by substituting a plan of pro¬ 
duction based on needs instead of demand. To this end he would tabulate 
the social needs and match them with social products. Business men would 
be instructed by the government as to the amount of goods to be produced 
and the wages to be paid. Labor coupons would displace money. Just enough 
of these coupons would be issued and in such a way as to enable the workers 
to purchase the whole of the social product. 

Other State Socialists attacked the competitive order more vigorously. 
Their contention was that it is inconceivable that an "increasing number 
of people could participate in the benefits of civilization” without the ag¬ 
gressive action of the state to make it possible. Instead of governmental in¬ 
action there was to be substituted a conscious governmental pervasiveness. 
This latter phase of State Socialism took form at the instigation of jurists, 
college professors, and administrators in the Eisenach Conference in 1872. The 
effort seems to have borne fruit in the well developed movement in the direc¬ 
tion of educational extension work. This work today is a part of many state 
colleges and universities. Although it has lost its revolutionary characteristics, 
its objective remains that of enabling an "increasing number of people to 
participate in the benefits of civilization.” 

(f) Marxian or "Scientific” Socialism.—It is something of a reflection 
on the results of our effort at educational progress that Marxian socialism 
has received the following that it has. Although referred to as "scientific,” 
there is nothing scientific about Marx’s writings. It is doubtful whether an¬ 
other widely read pseudo-philosophical work of the 19th century contains 
as many contradictions and superficialities. Yet it is Karl Marx’s book on 
Capital that really became, and still is, the "Bible of Socialism.” 


DOMINANT AND CONTESTING THEORIES SINCE 1756 13 


It is probably due to two facts that the Marxian socialism has so power- 
fully gripped the imagination of the working people. These facts are its 
simplicity of conception and its apparent fairness. Although constructed on 
the Ricardian theory of value—the doctrine that the value of a thing is 
determined by the amount of labor which it takes to produce it, the Marxian 
doctrines contains little of the depth of thought evidenced in the Ricardian 
treatment of the subject of value. The further fact that Ricardo, himself, 
was not satisfied with his explanation of value would have made one more 
profound than Marx hesitate to construct a whole philosophy of the social 
order on that concept. 

The pin-point of Marxian socialism is simply this: Since labor creates 
value to labor belongs all values. Those individuals who are drawing any 
part of the results of labor without themselves being laborers are exploiters 
of labor. The ability of those persons to live on labor is due to what he 
called "surplus value”—the difference between the amount the employers 
have to pay to secure the service of laborers and the amount for which the 
product will’ sell. Marx thought that the time would come when laborers 
would reach the end of their endurance of this exploitation and would rise 
in a body and seize the industries. Thereupon would be established com¬ 
munistic operation instead of private ownership. Marx went even further in 
that he taught that his mission was to instruct the proletariat in the methods 
of procedure after they had confiscated the industries. 

It is readily seen that Marxian socialism is excessively revolutionary. It 
teaches the workers that in seizing the employers* plants they are really 
taking back what belongs to them already. This fact explains why there 
has grown up such a fear of socialism, for if the thousands of workers 
become imbued with the gospel that the tools with which they work, 
and the great collections of machinery characteristic of the modern factory 
system really belong to them instead of to their employers, if such a doctrine 
as that becomes almost a religion with the hired men, we have a truly danger¬ 
ous social situation. 

The Anarchists .—It is hardly accurate to speak of the anarchists in many 
respects as contestants of the laissez faire doctrine. Anarchism is really laissez 
faire in its ultimate. The anarchists’ conception of the spontaneity of the 
economic order is in many respects similar to that of Adam Smith. 

Smith, however, thought of the government as a sort of guarantor of the 
effective operation of spontaneity. He found the principal justification for the 
government in its defence of private property. The anarchists teach that the 
right of private property gives rise to the worst of all tyrannies. They at¬ 
tempt to show, therefore, that only by the destruction of private property 
is it possible to usher in the ideal order. Since they believe that the only 


14 


THE EXPANSION OF ECONOMIC CONCEPTS 


effective way to destroy this right is to destroy the government, they teach 
the necessity of the destruction of the government. 

The abiding difference between the classical economists and the anarchists 
is found in the latter’s desire to substitute mutual aid for self-interest as a 
motive for productive effort. The laissez faire doctrine is postulated on an 
assumption that there is no conflict between self-interest and social interest. 
Because of that assumption the laissez faire economists thought that the 
hands-off policy on the part of the government was necessary for complete 
expression of self-interest better to promote the interest of the whole. The 
anarchist challenges this, asserting that self-interest is more likely to be 
injurious than beneficial to society. They desire therefore to force an order 
of mutual aid by violent destruction of the present regime. It is this desire 
to overthrow the established order of self-interest that classes the anarchists 
as contestants of the laissez faire system. 

The Historical School of Economists. —In spite of the wide popularity of 
many of the doctrines contesting the established order of laissez faire, none 
of them made a very serious impression on the trend of economic thought. 
The reason for this is no doubt to be found in the fact that there was little 
in their teaching that in any way seriously challenged the classical economists. 
The contestants had simply not fully comprehended the subject-matter with 
which they were dealing. 

Successfully to attack a scientist, one must either attack his method of 
reasoning or must make a more skillful use of the method employed. 

There developed, during the third quarter of the 19th century, a school 
of economists now known as the Historical School. These made a powerful 
attack on classical economists by resorting to the first of these plans, that 
of attacking the method of reasoning followed by the Classicals. The con¬ 
tention of the Historicals was that the deductive method is not scientific. 
Since classical economics followed the deductive method, according to the 
Historicals, the whole structure was improperly based. The work of build¬ 
ing the science of economics had to be done over in accordance with the 
inductive method of reasoning. Economic laws, therefore, must be discovered 
by the laborious process of inductive reasoning applied to the history of 
nations. The various exponents of the Historical School presented a different 
slant on this general proposition. For instance, William Roscher blazed the 
way and opened up the possibility of the use of the inductive method. He 
contended that economic laws were, in some respects, probably as already 
explained, but that they needed verification from history. Bruno Hildebrand 
set out the ideal of making the science over by resorting to historical analysis. 
In this analysis he expected to discover economic laws, and not necessarily 
those developed by the classical economists. Karl Knies denied the existence 
of economic laws and defined political economy as simply a history of ideas 


DOMINANT AND CONTESTING THEORIES SINCE 1756 15 


concerning the economic development of a nation at different periods of 
its growth. None of these earlier writers reached the full sweep of their in¬ 
fluence until the cudgel was taken up by Gustav Schmoller in 1870. 
Schmoller’s views conformed very closely to those advanced by Hildebrand. 
He set out to bring into existence historical treatises which would verify his 
contention that economic laws could be discovered by means of historical 
research. Between the years 1870 and 1900 there were a number of volum¬ 
inous works produced and called economic and industrial history. These were 
inspired by the point of view of the historical economists. 

Although it seemed for a time that the whole science of economics would 
have to be made over according to the inductive instead of the deductive 
method of reasoning, yet very little of tangible consequence resulted from 
the work of the Historicals. The great historical tomes which came from 
the press soon revealed the inadequacy of their method. The historians soon 
became lost in the maze of details. In the very works which they produced 
they frequently forgot the object of their study. Students of the history 
of economic thought fail to discover a single addition to the content of 
the science of economics made by these writers. The best discovery is credited 
to Hildebrand, namely, that there are three phases of economic development, 
the natural economy (barter), money economy, and credit economy. At any 
rate when the recovery came it came with revival of classical economics 
minus laissez faire. 

The defense of classical economics was undertaken by Karl Menger soon 
after Gustav Schmoller dazzled the intellects of Europe. Menger showed 
clearly that the Historicals were criticising the Classicals without first 
mastering their philosophy. When he was able to demonstrate, without pos¬ 
sibility of refutation, that most of the charges made against the Classicals 
would not stand the test of careful analysis there was much searching of 
hearts. Menger’s thesis was that it was not the use of the deductive method 
for which the early economists should be criticised but their abuse of that 
method. He, therefore, along with a number of his contemporaries set out to 
remove ambiguities from classical economics. As a result of this effort 
economics has been restored to the pedestal of respect which it occupied 
before the mid-nineteenth-century onslaughts. This brings us to the dominat¬ 
ing theory of the social order of our own time. 

THE DOMINATING CONCEPT OF ECONOMIC LAWS 

The worst condemnation that one can make of a proposed plan of social 
reform today is that it is economically unsound. This fact presents an entirely 
different view of economic laws from that which prevailed before 1850. 
The feeling then was that economic laws were something entirely apart from 
state action. It was then thought that legislation was nullified by economic 


16 


THE EXPANSION OF ECONOMIC CONCEPTS 


laws. Today no such hopeless attitude is taken toward state activity. At the 
same time there is greater respect for economic laws than has ever been ex¬ 
perienced before. Stated briefly, then, this is the dominant theory of the social 
order today. It is the fact that the behavior of man, whether that behavior 
relates to private or public affairs, should be in conformity with discoverable 
and in most instances discovered economic laws. This is not saying that all 
behavior tends so to conform, but that any that does not thus conform is 
frowned upon by careful students. 

This is nothing more than saying that in social matters as well as in 
physical the scientific spirit prevails. A good illustration of this changed 
attitude is found in the minimum wage. The classical economists’ attitude 
toward establishing by law a minimum wage would have been that of an 
absolute denial of the possibility, unless perchance the minimum required 
should be in conformity with the actual minimum as a result of the natural 
laws. Such a result would, of course, nullify the wisdom of the passage of 
the minimum wage law. The attitude toward minimum wage legislation is 
now entirely reversed. The approach to the problem today is somewhat as 
follows: (1) Can a working definition be formulated? (2) Is a minimum 
wage possible with the total income as it is? (3) What are the peculiar 
difficulties which face the state in administering a minimum wage program? 
(4) Would the result be worth the effort? 

If these questions can be answered satisfactorily then the economist places 
his stamp of approval on the minimum wage proposition. If they cannot be 
answered satisfactorily his approval is not forthcoming. The mere fact that 
a state has or has not passed such a law would in no way interfere with the 
logicality of the proposal. 

It is not accurate to say that the present order does not contain its con¬ 
testants. An analysis of these will be made in the process of discussions to 
follow. Practically all of the writers on economics today, however, assume 
the scientific attitude. 

One further comment should be made. No longer is there any dispute 
among scientists as to what constitutes the scientific method. Professor Gide 
has well stated the proposition as follows: 

"The opposition between the deductive and the inductive method is somewhat academic. 
In reality there is but one method, which proceeds by three stages: 

“(1) To observe facts, without any preconceived notions, and especially those facts that 
at first seem most insignificant; 

"(2) To imagine a general explanation which will enable us to connect certain groups 
of facts together in a relation of cause and effect; in other words, to formulate a hypothesis; 

“(3) To verify this hypothesis by finding out, if not by actual experiment, then at least 
by observation carried out in a special manner, whether the application of the hypothesis 
exactly fits the facts. 

“This is the procedure followed even in the physical and natural sciences. All great laws 
which lie at the foundation of modern sciences, from Newton’s law of gravitation downwards, 
are only verified hypotheses. We may go further than this, and say that the great theories 
which have served as bases for the scientific discoveries of our own day—such as the existence 


DOMINANT AND CONTESTING THEORIES SINCE 17 5 6 17 


of ether in physics, and the doctrine of evolution in the natural sciences—are only unverified 
hypotheses.” (Principles p. 17). 

In spite of this very clear exposition of what constitutes the scientific 
method we can nevertheless classify modern economists in accordance with 
whether or not they have a leaning in the direction of one or the other of 
the methods. 

References. —A comprehensive list of references for the ground covered 
in the chapter just completed would include all of the important works on 
economics during the last century and three-quarters. The following list of 
references is given not so much with the view of furnishing a list of books 
which the students are expected to read as that of making an arrangement 
of the authorities which are outstanding in the various schools of economists. 
Throughout the study other authorities are referred to than those mentioned 
in the list here given. 

1. General Interest: 

Gide and Rist: History of Economic Doctrines. 

Alfred Marshall: Principles of Economics. 

Spann: History of Economics. 

Haney: History of Economic Thought. 

A critical study of these works will give a fair comprehension of the 
whole field of economics. 

0 

2. Classical Economists'. 

(1) The Physiocrats: 

Quesnay: Tableau Economique. 

Mercier de Reviere: UOrdre Natural. 

Dupont de Nemours: Physiocratie. 

Turgot: Reflexions. 

Higgs: The Physiocrats (a secondary authority.) 

(2) The so-called fathers of political economy: 

Adam Smith: Wealth of Nations. 

J. B. Say: Treatise on Political Economy. 

T. R. Malthus: Essay on Population. 

David Ricardo: Principles of Political Economy and Taxation. 
J. S. Mill: Principles of Political Economy. 

3. Contestants of Classical Economics'. 

(1) Compromising economists: 

Lauderdale: Public Wealth and Its Increase. 

Rae: New Principles of Political Economy. 

Sismondi: New Principles of Political Economy. 

List: National System of Political Economy. 


18 


THE EXPANSION OF ECONOMIC CONCEPTS 


(2) Socialists: 

(a) Socializing: 

Saint Simon: Systeme industriel. 

Bazard: Exposition de la Doctrines de Saint Simon. 

(b) Associatists (Utopians): 

Robert Owen: New Moral World. 

Charles Fourier: Nouveau Monde industriel. 

(c) State Socialists: 

Rodbertus: Forderungen; also Sociale Briefe. 

Wagner: Grundlegung. 

Dupont-White: Ulndividu et I’Etat. 

(d) Christian Socialists: 

Le Play: Le Re forme Sociale. 

Francis Huet: Le Regne social du Christianisme. 

Charles Kingsley: The Church’s Message to the Workers. 
John Ruskin: Munera Fulveris. 

Thos. Carlyle: Fast and Present; also Chartism. 

Tolstoi: Labour. 

(e) "Scientific” Socialists: 

Karl Marx: Das Kapital; also Communist Manifesto. 
Bernstein: Die Voraussetzungen des Sozialismus. 

(f) Fabian Socialists: 

Bernard Shaw: The Fabian Society. 

Sidney Webb: Fabian Essays. 

H. G. Wells: Outlines of History. 

(3) The Anarchists: 

Proudhon: Contradictions economique. 

Stirner: Der Einzige und sein Ei gent hum. 

Bakunin: Dieu et l’Etat. 

Kropotkin: Mutual Aid. 

(4) The Historical School of Economists: 

Wilhelm Roscher: Political Economy. 

Bruno Hildebrand: The National Economy of the Present 
and Future. 

Karl Knies: Political Economy from the Standpoint of the 
Historical Method. 

Gustav Schmoller: Grundriss der Volkswirtschafstelehr. 

Cliff Leslie: Essays on Political and Moral Philosophy. 

4. The Revival of the classical point of views 

(1) The forerunners: 

Frederic Bastiat: Harmonies. 

H. C. Carey: Principles of Social Science. 


DOMINANT AND CONTESTING THEORIES SINCE 1756 19 


(2) Neo-Classicals: 

(a) The Psychological: 

Karl Menger: TJntersuchen iiber die Met bode der Social- 
wissenschaften. 

Friederich von Wieser: Source and Principal Laws of Eco¬ 
nomic Value. 

Eugen von Bohn-Bawerk: Capital and Interest. 

J. B. Clark: Distribution of Wealth. 

(b) The Mathematicals: 

Jevons: Theory of Political Economy. 

Walras: Elements of Pure Political Economy. 

Edgeworth: Mathematical Psychics. 

Alfred Marshall: Principles of Economics. 

Irving Fisher: Elementary Principles of Economics. 

Moore: Synthetic Economics. 

(3) Neo-Historicals: 

W. C. Mitchell: Business Cycles. 

F. C. Mills: Behavior of Prices. 

Practically all of the publications of the National Bureau of 
Economic Research (New York). 

Note. —In this study we have chosen to designate as Classical economists 
those who follow the deductive method and as Historical those who follow 
the inductive method of reasoning. The modern, or professional economists, 
being scientists do not follow either method to the exclusion of the other. 
Those who lean in the direction of the deductive method are classed as Neo- 
Classicals, and those who lean in the direction of the inductive method—• 
the economic statisticians—we have classed as Neo-Historicals. 

Some authorities inject into the classification of economists another group, 
called the Nationalists. Among these they include Alexander Hamilton, 
Daniel Raymond, H. C. Carey, and Friedrich List. If economists are classified 
according to method we are unable to see that there is any place for the 
Nationalists. Insofar as the exponents of the so-called Nationalist doctrines 
do not subscribe to the Classical point of view they really belong with the 
Mercantilists. 

Of course, if one desired to classify economists according to another 
plan, say according to their solutions of the social problems, then there 
would be room for many different schools. The fact seems to be that persons 
who have concerned themselves with the classification of the economists 
have almost invariably shifted from one point of view to another in arranging 
their schools without deciding in advance upon any consistent plan of 
classification. 






Adam Smith (1723-1790) 


"The life of Adam Smith presents nothing remarkable. It is easily summed up in the 
story of his travels, his professional activities, and the records of his friendships, and among 
these his intimacy with Hume the philosopher has become classical. He was born in Kirk¬ 
caldy, in Scotland, on June 5, 1723. From 1737 to 1740 he studied at the University of Glas¬ 
gow under Francis Hutcheson, the philosopher, to whom he became much attached. From 
1740 to 1746 he continued his studies at Oxford, where he seems to have worked steadily, 
chiefly by himself. The intellectual state of the university was at that time extremely low, 
and a number of the professors never delivered any lectures at all. Returning to Scotland, he 
gave two free courses of lectures at Edinburgh, one on English literature and the other on 
political economy, in the course of which he defended the principles of commercial liberty. 
In 1751 he became Professor of Logic at Glasgow, at the time one of the best universities 
in Europe. Towards the end of the year he was appointed to the chair of Moral Philosophy, 
which included the four divisions of Natural Theology, Ethics, Jurisprudence, and Politics 
within its curriculum. In 1759 he published his Theory of Moral Sentiments, which speedily 
brought him a great reputation. In 1764, when forty years of age, he quitted the professorial 

(21) 









































22 


THE EXPANSION OF ECONOMIC CONCEPTS 


chair at Glasgow University and accompanied the young Duke of Buccleuch, son-in-law of 
Charles Townshend, the celebrated statesman, on his travels abroad. With the young nobility 
of this period foreign travel frequently took the place of a university training, on account 
of the disrepute into which the latter had fallen. Smith was given a pension of £300 a year 
for the rest of his life, so that the mere material advantage was considerably in excess of 
his earnings as a professor. The years 1764-66 were spent in this way. A year and a half was 
passed at Toulouse, two months at Geneva, where he met Voltaire, and another ten months at 
Paris. While in Paris he became acquainted with the Physiocrats, particularly with Turgot and 
the Encyclopaedists. It was at Toulouse that he began his Wealth of Nations. Returning to 
Scotland in 1767, he went to live with his mother, with the sole object of devoting himself 
to his work. By 1773 the book was nearly complete. But Smith moved to London, and the 
work did not appear till 1776. By this achievement Smith crowned the great celebrity which 
he already enjoyed. In January, 1778, Smith was appointed Commissioner of Customs at 
Edinburgh, a distinguished position which he held until his death. 

"All we know of Smith’s character shows him to have been a man of tender feelings 
and of great refinement of character. His absent-mindedness has become proverbial. In politics 
his sympathies were with the Whigs. In religion he associated himself with the Deists, a school 
that was greatly in vogue toward the end of the eighteenth century, and of which Voltaire, 
who was much admired by Smith, was the most celebrated representative. 

"For a long time the only life of Smith which we possessed was the memoirs written by 
Dugald Stewart, Account of the Life and Writings of Adam Smith, and read by him in 1793 
before the Royal Society of Edinburgh. It appeared in the Transactions of the society for 
1794, and was published in volume form in 1811, along with other biographies, under the 
title the Biographical Memoirs of Adam Smith, Robertson, etc., by Dugald Stewart. Today 
we are more fortunate. John Rae in his charming Life of Adam Smith (London, 1895) has 
succeeded in bringing to light all that we can know of Smith and his circle. To him we are 
indebted for most of the details we have given. In 1894 James Bonar published a catalogue 
of Smith’s library, containing about 2,300 volumes, and comprising about two-thirds of his 
whole library. A still more important contribution to the study of Smith’s ideas has been 
made by Dr. Edwin Cannan, who in 1896 published Lectures on Justice, Police, Revenue, and 
Arms, Delwered in Glasgow by Adam Smith, from Notes taken by a Student in 1763 
(Oxford). This represents a course of lectures on political economy delivered by Smith while 
professor at Glasgow. A manuscript copy of the notes taken in this course by a student, 
probably in 1763, was accidently discovered by a London solicitor in 1876. These notes were 
in 189 5 forwarded to Dr. Cannan for publication. They are especially precious in helping to 
understand Smith’s ideas before his stay in France and his meeting with the Physiocrats. Of 
the numerous editions of the Wealth of Nations which have hitherto been published the more 
important are those of Buchanan, McCulloch, Thorold Rogers, and Nicholson. The latest 
critical edition is that of Dr. Cannan, published in 1904 by Methuen, containing very valuable 
notes.”—Gide and Rist, History of Economic Doctrines, pp. 5 0-2, note. 


CHAPTER II. 


TPiE CONCEPT OF PRODUCTION 

Changing Definitions. —It is hardly too much to say that the test of 
an economist is to be found in his concept of production. Certainly all per¬ 
sons who can be dignified with the term economists have sensed the difficulty 
of accurately defining production. The man who is not an economist is more 
than likely not to have sensed that difficulty. 

Probably the confusion that arises with regard to that term grows out 
of the fact that economists do not resort to a distinct terminology. If econo¬ 
mists should have that which most other sciences have—a terminology of 
their own—the concept of production could be given a name and thereafter 
referred to by that name. The fact that economics does not have a termi¬ 
nology of its own is of special significance wfith regard to the concept of pro¬ 
duction. Everybody talks about production. 

Throughout the history of the science of economics students of the sub¬ 
ject have been attempting to clarify this concept. But as yet the job has 
not been finished. 

A surprisingly large number of definitions and tests of productive effort 
have to be abandoned as not satisfactory for the purpose of exact discrimina¬ 
tion. 

The Mercantilistic Contrasted with the Physiocratic Concept of Produc¬ 
tion. —Both the Mercantilists and the Physiocrats constructed their concepts 
of production on material things. Each thought of material things as making 
up the wealth of a nation. Wealth, in the eyes of the Mercantilists, however, 
took the form of treasure. Whereas, in the eyes of the Physiocrats it took 
the form of consumable commodities—food and clothing. According to the 
Mercantilists, therefore, only that activity is productive which adds to a 
nation’s treasure, whereas according to the Physiocrats that activity is 
productive only which adds to a nation’s food and clothing. Therefore Mer¬ 
cantilism found the principal source of wealth in foreign trade, whereas the 
physiocrats thought of agriculture and possibly fishing alone as productive. 
Trade, with them, whether domestic or foreign, did no more than transfer 
this wealth from one person to another or from one place to another. Trade, 
therefore, could not be considered productive. 


23 


24 


THE EXPANSION OF ECONOMIC CONCEPTS 


With the concepts of production as they were held by the Mercantilists 
and the Physiocrats, the identification of productive and non-productive 
activity was comparatively simple. But each had the defect of excluding 
from the pale of productive activities matters which clearly increased the 
wealth of a nation. The Physiocrats recognized artisans and traders as per¬ 
forming important—even essential services—yet they were thought of as 
parasites. The Mercantilists in practice, at least, limited their conception of 
productive activities to those activities specifically excluded by the Physio¬ 
crats. Needless to say both groups presented only a partial explanation of 
production. Further study was needed. 

Adam Smith’s Effort to Remove the Confusion .—The Mercantilists had 
no greater enemy than Adam Smith, nor did the Physiocrats have a greater 
friend. In his concept of production, however, Adam Smith differed sharply 
from both. Since Adam Smith’s whole concern was a study of the wealth of 
nations, naturally, he gave a great deal of attention to the nature and scope 
of production. 

His division of labor concept really constituted the foundation upon 
which he based his philosophy of production. If Mercantilistic emphasis on 
treasure was so much to be abominated, what was the fundamental basis of 
national wealth? Smith thought it to be labor. The nation is richest which 
has the most people at work. Division of labor is fundamental to effective 
labor. 

"It is the great multiplication of the productions of all the different arts, 
in consequence of the division of labour, which occasions, in a well-governed 
society, that universal opulence which extends itself to the lowest ranks of 
people. Every workman has a great quantity of his own work to dispose of 
beyond what he himself has occasion for; and every other workman being 
exactly in the same situation, he is enabled to exchange a great quantity, or 
what comes to be the same thing, for the price of a great quantity of theirs 
he supplies them abundantly .with what they have occasion for, and they 
accommodate him as amply with what he has occasion for, and a general 
plenty diffuses itself through all the different ranks of the society.” ( Wealth 
of Nations. Book I, Chapter I, p. 12.) 

Language like that marks a great advance over the previous concepts of 
production. When, however, Smith attempts to pin himself down to the 
distinction between productive and unproductive activity, he loses his poise. 
But even here he registers a gain over previous writers. Yet he stops short 
of a satisfactory exposition. 

"There is one sort of labour which adds to the value of the subject upon 
which it is bestowed; there is another which has no such effect. The former, 
as it produces a value, may be called productive; the latter unproductive 


THE CONCEPT OF PRODUCTION 


25 


labour. ... A man grows rich by employing a multitude of manufacturers; 
he grows poor, by maintaining a multitude of menial servants. The labour of 
the latter has its value, and deserves its reward as well as that of the former. 
But the labour of the manufacturer fixes and realizes itself in some particular 
subject or vendible commodity, which lasts for sometime at least after that 
labour is past. It is, as it were, a certain quantity of labor stacked and stored 
up to be employed, if necessary, upon some other occasion. That subject, or 
>diat is the same thing, the price of that subject, can afterwards, if necessary, 
put into motion a quantity of labour equal to that which had originally 
produced it. The labour of the menial servant, on the contrary, does not fix 
or realize itself in any particular subject or vendible commodity. His services 
generally perish in the very instant of their performance, and soldom leave 
any trace or value behind them, for which an equal quantity of service could 
afterwards be procured. 

"The labour of some of the most respectable orders in the society is, like 
that of the menial servant, unproductive of any value, and does not fix or 
realize itself in any permanent subject, or vendible commodity, which endures 
after that labour is past, and for which an equal quantity of labour could 
afterwards be procured.” (Wealth of Nations. Book II, Chapter III, p. 313.) 

An excellent exercise in economic concepts could be developed in show¬ 
ing the fallacious points of view presented in the quotation just given. For 
us, at this time, the interest lies in the test of productive effort. Value must 
survive the act. If that could be made the test, identification would be very 
simple. There are, however, so many kinds of activities, the results of which 
do not survive the act, which our sensibilities will not allow us to pronounce 
parasitical that we must reject Adam Smith’s test. 

In terms of modern economic analysis we should say that the Physiocrats 
classed as productive the activity which creates what has come to be called 
elementary or stuff utility. Smith extends the concept so as to include not 
only elementary utility but also form utility. Further he did not go. 

Adam Smith made even a worse error than that when he came to con¬ 
sider the importance of different occupations. He was unable entirely to 
free himself for the Physiocratic devotion to agriculture. 

"No equal capital puts into motion a greater quantity of productive 
labour than that of the farmer. Not only his labouring servants, but his 
labouring cattle, are productive labourers. In agriculture, too, nature labours 
along with man; and though her labour costs no expense, its produce has its 
value as well as that of most expensive workmen. . . . The labourers and 
labouring cattle, therefore, employed in agriculture, not only occasion, like 
the workmen in manufactures, the reproduction of a value equal to their own 
consumption, or to the capital which employs them, together with its own 
profits; but of a much greater value. Over and above the capital of the 


26 


THE EXPANSION OF ECONOMIC CONCEPTS 


farmer and all its profits, they regularly occasion the reproduction of the 
rent of the landlord. This rent may be considered as produce of those 
powers of nature, the use of which the landlord lends to the farmer. It is 
greater or smaller according to the supposed extent of those powers, or in 
other words, according to the supposed natural or improved fertility of the 
land. It is the work of nature which remains after deducting or computing 
everything which can be regarded as the work of man. It is seldom less than 
a fourth, and is frequently more than a third of the whole produce. No eoual 
quantity of productive labour employed in manufactures can ever occasion 
so great a reproduction.” {Ibid. Book II, Chapter V, p. 343.) 

It is easy for us now to comprehend the phenomena which Adam South 
was vaguely observing. One is that of economic rent, a thing which through¬ 
out his great work remained chaotic. His reference to the fourth and third 
of the product could hardly have any other meaning. The other is the life 
impulse. In most activities other than agriculture man deals with dead 
matter. Even in such work as mining he is thought of as drawing on an 
accumulated store of wealth. But in farming, and closely related enterprises, 
such as dairying, stock raising, and horticulture, the supply has a way of 
repleting itself if man is careful properly to nurture the life impulse. It must 
have been the life impulse which Smith had in mind when he spoke of 
"nature labouring along with man.” It must have been there also that he 
thought he saw the explanation of rent—what he considered the fruit of the 
iand. These concepts, though highly interesting, are none the less inaccurate. 

In conclusion we must state that although Smith made a notable effort 
to clear the concept of production of its ambiguities, the concept was not 
in a much more satisfactory state after his contribution than before. Smith, 
however, left an influence on the English economists from which they found 
it hard to free themselves. The continental writers, however, soon broke 
away from both the Physiocratic and the Smith concept of production. 

The Concept of Production in the Early Nineteenth Century French 
Economic Theory. —Even before the French Revolution the French econo¬ 
mists were beginning to break with the Physiocratic doctrine of production. 
Turgot mildly took issue with them on several points. Condillac, writing in 
1776, presented an advanced treatment on a number of economic concepts, 
among them the concept of production. 

But the work of demolishing the Physiocratic teaching regarding the 
nature of production was accomplished more skillfully by J. B. Say. The 
first edition of Say’s Treatise on Political Economy appeared in 1803. It did 
not find favor with Napoleon. Hence further editions did not appear till 
1814, and after. Say’s language regarding the concept of production is as 
follows: 


THE CONCEPT OF PRODUCTION 


27 


"Objects, however, cannot be created by human means; nor is the mass 
of matter, of which the globe consists, capable of increase or diminution. 
All that man can do is to reproduce existing materials under another form, 
which may give them an utility they did not before possess, or merly enlarge 
one they may have before presented. So that in fact, there is a creation, not 
of matter, but of utility; and this I call production of wealth” (American 
translation, 1836, p. 62.) 

The definition here presented would stand as fairly accurate in almost any 
modern text on economics. There is, of course, a slightly undue emphasis on 
form. Say, nevertheless, did not refine the concept of utility into the niceties 
of modern economic literature. It should be further noted that Say rose even 
nearer to the modern concept as is shown in the following quotation: 

"A physician goes to assist a sick person, observes the symptoms of 
disease, prescribes a remedy, and takes his leave without depositing any pro¬ 
duct, that the invalid or his family can transfer to a third person, or even 
keep for the consumption of a future day. 

"Has the industry of the physician been unproductive? . . . The industry 
of a musician or actor yields a product of the same kind; it gives one an 
amusement, a pleasure one cannot possibly retain or preserve for future con¬ 
sumption, or as the object of barter for other enjoyments. This pleasure has 
a price, it is true: but it has no further existence, except perhaps in the mem¬ 
ory, and no exchangeable value, after the instant of its production . . . The 
industry of the physician, however, as well as that of the public functionary, 
the advocate or the judge, which are all of them in the same class, satisfies 
wants of an essential nature, that without those professions no society could 
exist. Are not, then, the fruits of their labour real? They are so far so as to 
be purchased at the price of other material products, which Smith allows to 
be wealth; and by the repetition of this kind of barter, the producer of 
immaterial products acquire fortunes.” {Ibid. pp. 119-20.) 

With all of his fine logic Say fell short of a full comprehension of the 
nature of productive effort. He had to strain a point to include traders as 
producers. Instead of considering that they created utilities he pronounced 
them productive because they created exchangeable values. (See Treatise, 
Book I, Chapter 2.) This goes to show that Say had not clearly distinguished 
utility from value, and further that he had not grasped the concept of 
possession utility. And further, Say said, "Since wealth is composed of the 
value of things possessed, how can a nation be wealthiest when things are of 
the lowest price?” This inquiry shows that Say failed clearly to distinguish 
between wealth and value, a frequent oversight in discussions of production 
even in modern economic literature. 

The Late English Classical Concept of Production. —In England, however, 
the economists were more loyal to Smith’s test of production. John Stuart 


28 


THE EXPANSION OF ECONOMIC CONCEPTS 


Mill’s Principles of Political Economy is best thought of as a resume of 
economics as it had come to be in England by the middle of the ninteenth 
century. Explanations of points of this kind by Mill can safely be taken as 
illustrative of the best thought on the subject up to his time. 

Mill shows an understanding of the contention advanced by Say, but he 
was unwilling to accept it. The following quotations illustrate Mill’s theory 
of production: 

"Now the utilities produced by labour are of three kinds. They are: 

"First, utilities fixed and embodied in outward objects . . . This is the 
common case, and requires no illustration. 

"Secondly, utilities fixed and embodied in human beings ... To this class 
belongs the labour of all concerned in education; not only schoolmasters, 
tutors and professors, but governments, so far as they aim successfully at the 
improvement of the people. . . . 

"Thirdly and lastly, utilities not fixed or embodied in any object, but sub¬ 
sisting in mere service rendered; . . . Such, for example, is the labour of the 
musical performer, the actor, the public declaimer or reciter, and the show¬ 
man. . . . 

"We have now to consider which of these three classes of labour should 
be accounted productive of wealth, since that is what the term productive, 
when used by itself, must be understood to import. Utilities of the third 
class, consisting in pleasures which only exist while being enjoyed, and serv¬ 
ices which only exist while being performed, cannot be spoken of as wealth, 
except by acknowledged metaphor . . . 

"All labour is, in the language of political economy, unproductive, which 
ends in immediate enjoyment, without any increase of the accumulated stock 
of permanent means of enjoyment. And all labour, according to our present 
definition, must be classed as unproductive, which terminates in a permanent 
benefit, however important, provided that an increase of material products 
forms no part of that benefit. The labour of saving a friend’s life is not 
productive, unless the friend be a productive labourer, and produces more 
than he consumes. To a religious person, the saving of a soul must appear 
a far more important service than the saving of a life; but we will not 
therefore call a missionary or a clergyman productive labourers, unless they 
teach, as the South Sea Missionaries have in some cases done, the arts of 
civilization in addition to the doctrines of their religion. . . . 

"Unproductive labour may be as useful as productive; it may be more 
useful in point of permanent advantage. ...” .( Principles , Book I, Chapter 
III, Section 4.) 

The above rather extended quotation shows the powerful influence of 
Smith over the minds of his successors in England. The French writers 


THE CONCEPT OF PRODUCTION 


29 


broke away from it with regard to production. But the overpowering influ¬ 
ence of Mill during his day, leads us to conclude that the Mill, and hence a 
small modification of the Smith concept of production, prevailed during the 
greater part of the nineteenth century. 

The Modern Revised Definition of Production .—As was noted in the 
previous chapter, during the last twenty-five years of the nineteenth and 
the early years of the twentieth century, classical economics was submitted 
to a great deal of scrutiny. The result was that the science of economics was 
greatly modified. Among the important changes made was a more studied 
definition of production. Needless to say, the modern definition has broken 
almost, if not quite, completely with the labored definition worked out by 
Mill. As noted before, however, the present definition is not greatly in 
advance of that presented by Say. It does mark an advance over Say’s 
definition, nevertheless, in that it recognizes that the productive process 
involves the creation of at least five different sorts of utilities. These are, 
elementary (or stuff), form, time, place, and possession utilities. Although 
Say considered traders productive, as has already been explained, he found diffi¬ 
culty in defending his assumption. That was due to the fact that he did not 
recognize possession utility. 

The refinement of economic concepts developed mainly by the well- 
known Austrian school of economists opened the way for the revised defini¬ 
tion, and for the consequent break with the Smith survival of value concept. 

The Austrian economists, successfully removed a number of ambiguities 
from Classical economics. The most outstanding of these were: (1) why 
there can be only one price for goods of the same kind and quality at the 
same time in any given market; (2) why value is inseparable from scarcity; 
and, (3) why exchanges are mutually beneficial. The clearing up of these 
points made a foundation for a much more satisfactory definition of produc¬ 
tion. No longer is production defined as the creation of value, but instead it is 
now defined as the creation of utility. The term utility itself becomes 
sharply defined. Utilities and disutilities are balanced against one another in 
the discussion of productive effort. Utility becomes distinguished from value 
and value itself is split up into value in use (subjective value) and value in 
exchange (objective value). Value in exchange is shown to be not exactly 
co-existent with price. Economists are in agreement today, therefore, on a 
definition of production, whether English. French, German or American. 
Any activity which creates a utility is productive. A fuller development of 
the economic principles relating to this concept in its relation to value and 
price is made in Chapter VI. 

Economics versus Ethical Considerations. —The fact that econo¬ 
mists have chosen the word utility—a word of common usage—to give mean- 


30 


THE EXPANSION OF ECONOMIC CONCEPTS 


ing to the term production is itself likely to cause confusion. If economics: 
had a terminology of its own that confusion could readily be avoided. That, 
however, is impossible here as elsewhere because of the very nature of the 
subject. The best that can be done is to select the word in popular use which 
is most nearly adapted to the idea intended to be conveyed. In choosing the 
word utility and adapting it to the purposes of economics the word has to 
be divorced from its ethical significance. In no sense should the word carry 
the idea of merely beneficial. The fact is that the result of the productive 
act may even be harmful. The term as employed in modern economic litera¬ 
ture simply means the quality of satisfying human desire. In fact, as will be 
shown later, economists are sometimes tempted to extend the meaning of 
the word too far. They are so intent upon the separation of the economic 
from the moral significance that they lean backward in some of their refine¬ 
ments of the concept. 

Tests of Productive Activity. —Since modern economists are so well 
in agreement on the definition of production, it would seem that they would 
likewise be in agreement as to their test of what particular activities are and 
which are not productive. In fact in a large way they are in agreement here 
also. But they are not in agreement as to just what should be the test to 
apply to tell when an activity is productive. 

For an exact identification of production the Smith test might even 
function better than the modern test. The Smith test, however, had to be 
rejected for the simple reason that too many things had to be excluded 
which should clearly not be dubbed parasitical. Yet certain extensions of 
the modern concept of production lead us to count as productive activities 
which are clearly parasitical. The real problem is to find a test that at the 
same time conforms to the definition and does not do violence to good sense. 

Before proceeding further let us examine some of the tests as given in 
prominent modern economic treatises. 

''Economic production is the bringing about changes appropriate to com¬ 
mand a price; it is in response to price-paying disposition. Anything that 
meets this test is economic production, and nothing else is.” (H. J. Daven¬ 
port’s Economics of Enterprise, p. 121.) 

We have in that a surprising statement to come from one otherwise so 
logical. It can be easily shown to be inconsistent with other points made 
by Professor Davenport later in his book. It is further, a very unsafe guide 
by which to judge productive effort."' 

To show that the test is inconsistent with Davenport’s own philosophy we 
have only to refer to his condemnation of persons who resort to price manipu¬ 
lation. Persons who resort to such practice are called by him "plunderers” 

*We are informed that in Chicago killers of men can be hired for a price! 



THE CONCEPT OF PRODUCTION 


31 


(see page 462, ibid.). His price test, therefore, falls before his own onslaught. 

In the very nature of the case this has to be so. It is clearly possible for 
price to appear as a result of reduction of wealth. Goods which are free may 
even be controlled in such a way as to make them valuable. It is true that 
usually the result of productive effort does command a price. But clearly the 
price test cannot be "the only test”. In fact it is not a safe identification 
mark. 

Taussig discusses at considerable length the matter of testing produc¬ 
tive effort. His interesting decision follows: 

"To enter on inquiries about the final effect of human welfare would 
raise many questions of different sort from those within the strict range of 
economics; inquiries which, if consistently followed in all cases, would range 
into almost every field of knowledge. There are physiologists who believe 
that meat, though men like it, is unnecessary for nourishment. Others main¬ 
tain that such stimulants as tea and coffee are of ill effect; that health and 
happiness are promoted by abstinence from them. To judge between these 
various advocates and reformers is no part of the essential task of the econo¬ 
mist. So long as a person who buys a thing or pays for a service really 
desires it the labor which yields him a satisfaction is productive.” (Princi¬ 
ples of Economics, Third Edition, Vol. 1, p. 22). 

Thus those who maintain gambling establishments are producers, whereas 
the professional gamblers are not producers. The manufacturer of burglars’ 
tools is a producer, whereas burglars, of course, are predatory. Taussig’s test 
is the genuineness of the service. A manufacturer of patent medicine is a 
producer even though the benefit of the drug is merely imaginary. Yet 
a creator of a concoction which exactly resembles the supposed medicine in 
appearance is a fraud. In this case he is not supplying the object of desire. 
The test is the genuineness of the service. If the service is genuine and 
desired the act is productive, according to Taussig. Further than that, in his 
opinion, the economist cannot go. 

Thus the accepted definition of production has brought us to pronounce 
as productive activities which, if not directly, are indirectly parasitical. It 
would seem, therefore, that the test of productive effort here given is almost 
as illusory as that given by Adam Smith. It forces us to include activities 
which our good sense forbids. 

Alfred Marshall proceeds with greater caution in his discussion of the test 
of productive effort. After an extended discussion of the nature of wealth, 
he makes the following guarded statement: "When we use the term produc¬ 
tive by itself, it is to be understood to mean productive of the means of 
production and of durable sources of enjoyment. But it is a slippery term, and 
should not be used where precision is needed. 


32 


THE EXPANSION OF ECONOMIC CONCEPTS 


"If ever we want to use it in a different sense, we must say so: for 
instance we may speak of labour as productive of necessaries, et<p.” ( Principles 
of Economics, Book II, Chapter III, Section 2.) 

Since Marshall is the successor of Mill and Smith, we can only conclude 
from the above statement that he has not been able entirely to break with 
the past. He still retains, at least in his subconscious mind, the old survival of 
value concept. He is, nevertheless, careful in another place to define produc¬ 
tion as the creation of utilities. He is also careful to state that traders produce 
utilities. In a broad way he includes the many activities in his enumerations 
which Smith and Mill did not include. 

The term production has such a wide use and in many places has taken 
on such an exactitude that it is unfortunate that economists have left it in 
such an unsatisfactory state. We speak glibly of the productivity theory of 
interest, and of the marginal productivity of labor. We assert with assurance 
that speculators are producers. Yet economic literature does not afford a 
uniform test of productive as distinguished from unproductive activity. In 
a general way the authorities are agreed with regard to enumerated activities 
which should be considered unproductive, but there are certain shades of dis¬ 
tinction which remain provokingly indefinite. It is largely because of that 
fact that the professional economists have difficulty in convincing the laymen 
that certain activities, which on the face do not appear productive, should 
in fact be so considered. 

The Surviving Confusion Analysed. —The cause of the confused 
state of economics with regard to the concept of production appears trace¬ 
able to mainly three sources, namely: (1) The failure to distinguish accu¬ 
rately between wealth and value; (2) The failure to recognize widely the 
fact that an activity in and of itself is not necessarily productive or unpro¬ 
ductive. In fact it may be either. (3) The failure to separate completely the 
individual from the social point of view. 

Wealth versus Value. —A statement that occurs consistently in treatises 
on economics is that wealth is composed of economic goods. This is thought 
of as being synonymous with the sum total of valuable goods. A represen¬ 
tative statement is the following: 

"Wealth comprises all articles of value and nothing else. If anything has 
not value, it does not belong to this category. It may conceivably be better 
than wealth; but it is certainly other than wealth. It may be a means of 
acquiring wealth; but it is not wealth itself. In the language of Prof. N. W. 
Senior, The words wealth and value differ as substance and attribute. All 
those things, and those only, which constitute wealth, are valuable.’ ” 
(Francis A. Walker’s Political Economy, Third Edition, p. 4.) 


THE CONCEPT OF PRODUCTION 


33 


A few economists, following Lauderdale, who wrote in the early years 
of the nineteenth century, have recognized the inconsistency of that state¬ 
ment. But their influence does not seem to have made a far-reaching impres¬ 
sion on the field of economics as a whole. The eminent French economist, 
Prof. Gide, called attention to the distinction between wealth and value 
in the following quotation: 

"In ordinary speech the words 'wealth’ and 'value’ are synonymous. But 
in political economy they bear meanings which are by no means identical, 
and in some respects even opposite to each other. 

"(1) The idea of wealth implies a relation between man and things, 
whereas value implies a relation between things —a relation that takes actual 
form in the shape of exchange, or if that is impossible, as when things are too 
far apart in space or time, in the shape of a statement of value. . . . 

"(2) The idea of wealth is necessarily bound up with that of abundance; 
the more goods a man has the wealthier he is. But the idea of value, on the 
other hand, is bound up with scarcity —of limitation of quantity . . . 

"Suppose, . . . that in the progress of science and industry, all objects 
become as abundant as the water of the brooks or the sand of the seashore, 
so that men can satisfy their wants by merely drawing upon them at will. 
In this case it is obvious that everything will have lost all exchange value, 
for there can be no exchange of objects which are free to all.” ( Principles of 
Political Economy, Chapter III, pp. 41-43.) 

The point of view presented by Prof. Gide seems irrefutable to the writer. 
Wealth is the result of abundance, whereas value is due to scarcity. It is cer¬ 
tainly theoretically conceivable that wealth might increase to such an extent 
that values would decline to the vanishing point. 

We have here a reasonable explanation why economists have, in their dis¬ 
cussions of production oscillated between the concepts of wealth and value. 
Sometimes they represent productive activity as resulting in the increase in 
wealth and at other times as resulting in the increase of valuable goods—• 
forces that are more than likely to be counteractive of each other. 

If the student will, once and for all, remember that the object of pro¬ 
ductive effort is the creation of wealth, and not necessarily the creation of 
valuable goods, he will have gone a long way in the direction of laying a 
foundation for the determination what is and what is not productive activity. 
Commodities may be made more valuable by the reduction of their supply, 
but wealth can be augmented only by a total additional output. Whether the 
point of view is that of the single commodity or service, or that of goods in 
general, the fact remains the same. The fact is that if any particular good 
is suddenly increased out of line with other things its value is almost certain 
to fall. If all goods should be increased in exact proportion values would 
probably not change at all. Utilities, however, would be affected. 


34 


THE EXPANSION OF ECONOMIC CONCEPTS 


All of our wants would be more nearly satisfied. Society would be better off. 

Now, production, correctly defined, as all economists have come to 
agree, means the creation of utilities, the augmentation of wealth. As a 
scientific concept, therefore, both production and wealth should be thought 
of as distinct from value. Value may react on the one or the other, favorably 
or unfavorably. But value and wealth do not necessarily vary together. 
Utility, wealth, and production should, however, be logically and consistently 
associated. Unfortunately this is not always done. 

The Same Activity May be Either Productive or Predatory. —There is 
not the same confusion in this respect in economic treatises as exists with 
regard to wealth and value. There is, nevertheless, an extensive effort to 
classify certain activities as productive or predatory in and of themselves. It 
is somewhat puzzling that economists have done this, when in so many other 
respects they have been careful not to speak too categorically. Goods may be 
capital or consumptive goods, depending upon the use to which they may 
be put; similarly exertion may be work or play, depending on the end sought. 
Why should not business projects be considered productive or predatory in 
and of themselves? Why should not the point of determination be that of 
whether or not the effect is to increase utility or value? If the primary effect 
is to increase value, more than likely the act is not productive, whereas if 
it is to create utility it is productive. A group of gamblers, for instance, 
may conceivably be producing amusement to a group of spectators. They 
may, in fact, be so clever in their pursuit that persons would be willing to 
pay for the privilege of witnessing their game. In that instance even Prof. 
Davenport would have to concede that gambling is productive. Even war, 
the most destructive pursuit known to man, might make additions to the 
sum total of utilities. This addition can and does take form in literature, art, 
science, engineering, medicine, and other ways. The last war certainly added 
to the wealth of the world in a number of ways. The "Caterpillar” tractor 
is one illustration. Others are found in the field of medicine, etc. In that 
sense war must be considered productive. The fact that society might be 
better off if the war had not happened is aside from the point. The deter¬ 
mining fact is that society is better off because of these additional accom¬ 
plishments than it would be without them. They are here and they are trace¬ 
able to war. 

The fact is that there is a sense in which almost, if not every activity 
can be considered productive, or unproductive, depending upon the point of 
view. 

Tlje Differentiation of the Individual from the Social Point of View .— 
A greater cause of confusion in the distinction between productive and 
unproductive activity is the failure to distinguish the individual from the 


THE CONCEPT OF PRODUCTION 


35 


social point of view. If there did not exist the conflict between the individual 
and social interest a distinction of the kind here brought out would be 
unnecessary. But the conflict does exist. The fact is that all predatory— 
"plundering”—activities, if successful, are profitable—"productive” to the 
individual or private interest sponsoring them. They can be pronounced un¬ 
productive only if the point, of view is shifted to society as a whole. They 
reduce the wealth of the community. 

Nor does the fact that a utility vanishes with the performance prevent 
it from adding to the sum total of human satisfaction. Life is richer bv the 
hearing .of the opera. It is even richer by the laughter precipitated by a clown. 

A further fact becomes evident. All predatory activity serves to increase 
value. The burglar’s act increases value because he makes goods scarce. The 
monopolist by reduction of output increases value. An increase in value, 
therefore is more likely to be a sign of predatory activity than of productive 
effort—private gain at the expense of social welfare. 

If it were practical to limit the use of the word productive, or production, 
to its social import there would be little if any difficulty in once and for all 
clearing up the confusion that tends to run with the concept. If it were 
even possible to pause each time and indicate the point of view in which the 
word is employed, the confusion might be avoided. But these precautions 
are quite impracticable. It seems that we must simply recognize that the word 
has two uses. The one relates to private gain and concerns value instead of 
wealth, whereas the other relates to social gain and concerns utility and 
wealth. The use of the term in the expression marginal jrroductivity of labor 
or capital is an illustration of the first signification. But when we say that 
even war may be productive the use is social and the word has there the 
second signification. Yet each of these statements may mean the reverse. 

As will be shown later, under the system of economic freedom there is 
an intimate connection between the individual and social welfare. Competi¬ 
tion has a way of forcing, at times, the subordination of the individual to 
the social interest. But the two concepts are separable and distinct, and all 
too frequently antagonistic to each other. 

To be more specific: why, for instance, is gambling in and of itself not 
productive? The money that passes does so without mutual benefit to the 
parties concerned. The one loses and the other gains. Activities to be socially 
productive, at the very minimum, must carry a mutual gain. Of course, the 
more productive activities do more than carry merely a mutual gain. Society 
as a whole gains as well. Activities which do not carry mutual gain vary all 
the way from mere exploitation to outright robbery. Gambling occupies an 
intermediate stage between exploitation and robbery. It is socially harmful 
because, if the practice should become too extensive the loss of the services of 
those addicted to the practice might conceivably jeopardize the welfare of 


36 


THE EXPANSION OF ECONOMIC CONCEPTS 


the whole community. To whatever extent indulged in the same effect, in 
a smaller way, is present. Furthermore, even though in the private sense, 
gambling may be considered productive to the winner, yet the money won 
in a bet loses utility. It is worth less to the winner than the same amount 
would be to him if he had earned it. Similarly the loser, unless the sum lost 
has itself been won at a bet, has given up the possibility of securing a satis¬ 
faction equivalent to the sacrifices made in earning the money. Gambling is, 
therefore, in and of itself, socially unproductive and individually highly 
injudicious. 

An activity very similar, in its outward aspects, to gambling is that of 
speculation, or dealing in futures, on stock and commodity exchanges. If a 
person bets on a horse race, however intelligently, he gambles, whereas if he 
buys or sells on the futures market intelligently he is, economically speaking, 
a producer. The reason is that the bet passes without mutual or social gain. 
When the skilled speculator buys or sells a futures contract his activity influ¬ 
ences the market for the commodity or security in which he deals. The influ¬ 
ence of speculators extends throughout society. The practice of hedging— 
an insurance against loss from price changes—is made possible. In general a 
better market is made possible for the thing dealt in. The results are both 
mutual and social. Dealing in futures, therefore, is productive whereas betting 
on horse races, or anything else, cannot be so considered. Gambling is of 
course possible on the exchanges. But the experienced speculator finds the 
practice both harmful to him and to the business at which he makes his 
living. A fuller discussion of this point is taken up later. 

It is also evident that a manufacturer of burglars’ tools can not be con¬ 
sidered productive. The only mutual gain conceivable is that involved in the 
exchange between him and the burglar. That transaction can hardly be 
thought of as anything other than a conspiracy between the parties against 
the wealth and safety of society. Similarly for persons who conduct gambling 
establishments, although these cases may not be altogether as flagrant as the 
case of the burglars’ tools. 

The same reasoning does not apply to cases where there is genuine mutual 
satisfaction such as that contained in the purchase and sale of opium or of 
alcoholic liquors. In these cases the factor of mutual gain is certainly very 
narrowly limited. But it is here that we enter the province of the moralist and 
the judge. 

In conclusion we may say that whenever more than one person is con¬ 
cerned for an activity to be productive there must be a mutual gain. This 
does not mean that each person has to be equally benefited. Almost never will 
that be possible. It implies only that the utility gained in each case will be as 
great as that parted with. In many cases, possibly in most cases, each person 
will gain more than he has given up. 


THE CONCEPT OF PRODUCTION 


37 


It is entirely possible for an act to be productive when only one’s own 
desires are concerned. The second party to the transaction is not essential 
to a productive act. The search for water on the part of a thirsty man is a 
productive act. Any effort to find a means of satisfying an honest desire, if at 
all successful, is a productive act. Whenever it affects the welfare of another 
person, or other persons, however, the act to be productive must not deprive 
others of wealth without giving in exchange that which is worth at least as 
much to the person receiving it as that which has been given up. 








Thomas Robert Malthus (1766-1834) 

"Thomas Robert Malthus was born in 1766. His father, a country gentleman, was a 
man of learning and a friend of most of the philosophers of his time, especially Hume, and, 
it also seems, J. J. Rousseau. He was the youngest son of the family, and was intended for 
the Church and given an excellent education. After leaving Cambridge he took a living in 
the country, but in 1807 was appointed professor at a college founded by the East India 
Company at Haileybury, in Hertfordshire, where he remained until his death in 1834. He 
married when thirty-nine years of age, and had three sons and a daughter. 

"Malthus was a young unmarried clergyman living in a small country ''Irish when, at 
the age of thirty-two, he in 1798 published anonymously his famous Essay on the Principle of 

39 








40 


THE EXPANSION OF ECONOMIC CONCEPTS 


Population as it Affects Future Improvement of Society. His critics were legion. In order to 
devote more study to the subject, he took a three years’ tour (1799-1802) on the Continent 
—avoiding France, because France at this period was anything but inviting to an Englishman. 
In 1803 he published—under his own name this time—a second edition, much modified and 
amplified, and with a slightly different title: An Essay on the Principle of Population, or a 
View of its Past and Present Effects on Human Happiness. Four other editions were published 
during his lifetime. 

"We must not forget his other works, although they were all eclipsed by his earliest 
effort. These were: The Principles of Political Economy considered with a View to their Prac¬ 
tical Application (1820); A Series of Short Studies dealing with the Corn Laws (18 14-1 5 ); 
On Rent (1815); The Poor Lav.v (1817); and finally his Definitions in Political Economy 
(1827).”—Gide and Rist, History of Economic Doctrines, p. 120, note. 


CHAPTER III. 


THE CONCEPT OF ECONOMIC LAWS 

The Physiocratic Natural Order Thesis. —The reason why the 
Physiocrats are considered the founders of the science of economics is the fact 
that they were the first persons who seriously attempted to discover the laws 
which control production, distribution, and consumption. The system which 
they worked out remains to this day one of tremendous interest. Even though 
the interest is largely inspired by curiosity rather than by admiration, yet 
the fact remains that there were many points of view advanced by the Physio¬ 
crats which to this day can be examined with profit. To us the matter of 
prime importance is their natural-order concept. In their effort to discover 
the principles of the natural order they blazed the way for the discovery of 
economic laws. In their effort to formulate the principles of the natural order 
the Physiocrats are best thought of as grasping after the concept of economic 
laws. If thought of in that light the natural-order thesis assumes an air of 
importance impossible for it if studied in any other light. 

The outstanding features of the Physiocratic natural-order thesis were: 

(1) It was assumed to be an order ordained by God for man. It was, 
therefore, a providential order. It was the duty of man to give attention to 
this providential order with the view of bringing his conduct into conformity 
with it. If men—particularly governmental officials—failed to bring their 
conduct into conformity with the natural order the consequences were 
thought by the Physiocrats likely to be disastrous. 

(2) The distinguishing mark of the natural order was its obviousness. 
God had planted in the mind of each man a light which enabled him to 
discover the principles of the natural order. Man would, therefore, find within 
himself "an inarticulate conception” of the natural order. 

(3) The principles of the natural order, however, were those attributed 
to it in the writings of the Physiocrats. They must have thought that all 
sensible persons who sought for the Divinely ordained system would discover 
the same content as that discovered by them. As it came about, nevertheless, 
only in the writings of the Physiocrats could there be found the concrete 
source of authority for any definite concept of the natural order. 

It is this last point that gives their system particular interest to us, for it 


41 


42 


THE EXPANSION OF ECONOMIC CONCEPTS 


was in their effort to discover and reduce to written form the principles of 
the natural order that the search for economic laws was begun. Needless to 
say, the Physiocrats were not themselves in all respects in agreement. This 
divergence of opinion also had a stimulating effect in the direction of the 
refinement of economic concepts. 

Allusion was made in the previous chapters to some of the points advanced 
by the Physiocrats. At this point we shall have a closer view of their whole 
system. 

They started with the assumption that agriculture alone was productive. 
Proof of that assumption seemed unnecessary. It amounted to the projection 
on paper of a popularly accepted dogma. Their problem was, therefore, to 
trace the course of the goods produced so as to account for (1) the distri¬ 
bution of wealth as they saw it all about them, and (2) to suggest modifica¬ 
tion of governmental policy so as to secure a happier population. The Physio¬ 
crats were not only analysts but they were also social reformers—social 
reformers who believed in placing a program of reform on what they thought 
to be correct economic analysis. 

Those who have studied the social arrangements as they existed in France 
prior to the French Revolution have little difficulty in comprehending the 
Physiocratic analysis of the relation between the production and distribution 
of wealth. It is necessary only to recall the position of the landed proprietors 
as contrasted with the peasants and artisans. The first lived in ease and 
luxury, whereas the other two classes barely existed. It may be true that the 
French peasants were better off than the peasants of other countries in con¬ 
tinental Europe. But the contrast between the landed proprietors and the 
other classes was such as to show two classes that barely made a living and a 
third class that lived on a respectable income without having to work. The 
problem for the Physiocrats was to show how and why it was econonrcally 
possible for the proprietors to live in luxury without working. They found 
the answer in their concept of the net product. 

The demonstration of the process through which the result of productive 
effort passed from one class to another called for a niceity of distinction 
hardly surpassed by later authorities. If only their first assumptions had been 
accurate the structure built upon them would have been beyond dispute. 
They, themselves, were so much attracted by their own system of analysis 
that they considered it one of the three great discoveries of man: 

"There have been since the world began three great inventions which have 
principally given stability to political societies, independent of many other 
inventions which have enriched and advanced them. The first is the inven¬ 
tion of writing, which alone gives human nature the power of transmitting 
without alteration its laws, its contracts, its annals, and its discoveries. The 
second is the invention of money, which binds together all relations between 


THE CONCEPT OF ECONOMIC LAWS 


43 


civilized societies. The third is the Economical Table, the result of the other 
two, which completes them both by perfecting their object; the great dis¬ 
covery of our age, but of which our posterity will reap the benefit.” (Quoted 
from Mirabeau , in a footnote on p. 18 , Gide and Rist’s History of Economic 
Doctrines.) It was in this tableau economiqtie —the Economical Table— 
that we find their description of the passage of the goods from one class to 
another. 

Simplified, their explanation meant that there was a net product from 
agriculture above the amount needed to keep the peasants. It was because 
of the existence of that net product that the proprietors could live without 
working. They received the net product from the farmers in the form of 
rentals. The artisans were a sterile class since they only worked up the pro¬ 
ducts. Since the proprietors needed some of the artisans’ wares a portion of 
their income went to the artisans to pay for these. Since the farmers had to 
have implements a portion of their income went to the artisans to pay for 
these also. The artisans, therefore, had no trouble in obtaining enough of 
the produce to maintain themselves, for they had to be maintained or their 
services would not be forthcoming. It worked out, therefore, that each class 
had about the same amount of the annual produce to live on. But life was 
made possible by agriculture, which was practically the only productive 
activity. The landlords drew theirs because they owned the land. They made 
it possible for the farmers to have a place to work; the artisans drew theirs 
because their services were needed both to the landlords and farmers; the 
farmers simply retained enough of the yield to keep them.* Since the pro¬ 


vince the above statement of the Physiocratic tableau economique avoids the illusive 
manner of presentation as given by the Physiocrats, the following quotation is given as a 
better statement of the whole proposition: 

"Let us suppose, then—the figures are Quesnay’s and seem sufficiently near the facts— 
that the value of the total wealth produced equals 5 milliard francs. Of this 5 milliards 2 
milliards are necessary for the upkeep of the members of this class (the farmers) and its 
oxen during harvest and sowing. This portion does not circulate. It simply remains where it 
was produced. The produce representing the remaining 3 milliards is sold. But agricultural 
products alone do not suffice for the upkeep of Class 1. Manufactured goods, clothes, and 
boots, are also required, and these are got from the industrial classes, for which a milliard 
francs is given. 

"There remain just 2 milliards, which go to the landowners and the Government in rents 
and taxes. By and by we shall see how they attempted to justify this apparent parasitism. 

"Let us pass to consider the propertied class. It manages to live upon the 2 milliards 
which it receives by way of rents, and it lives well. Its food it must obtain from the agricul¬ 
tural class (unless, of course, rents are paid in kind), and for this it possibly pays a milliard 
francs. It also requires manufactured goods, which it must get from the sterile class and for 
which it pays another milliard francs. This completes their account. 

"As to the sterile class, it produces nothing, and so, unlike the preceding class, it can 
only get its necessaries second-hand from the productive class. These may be got in two 
ways: a milliard from the agricultural class in payment for manufactured goods and another 
milliard from the landed proprietors. The latter milliard being one of the two which the 
landed proprietors got from the agriculturalists, has in this way described the complete circle. 

"The 2 milliards obtained as salaries by the sterile class are employed in buying the 
necessaries of life and the raw material of industry. And since it is only the productive class 
that can procure these necessaries and raw materials, this 2 milliards passes into the hands 



44 


THE EXPANSION OF ECONOMIC CONCEPTS 


prietors did not work, the source of their income was the net product —a 
clear gain. The absence of work coupled with the fact that in actual num¬ 
bers they were fewer than the other classes explained their luxurious living. 

There are many evident fallacious assumptions in the tableau economique. 
But it was an ingenious explanation of the social order in which they lived. 
The matter of greatest significance about the whole thing relates to the con¬ 
clusion which they drew from it—the way that they fitted it into their 
natural-order concept. 

It is in this connection that we discover the peculiarity of the Physiocratic 
laissez faire doctrine. Here also we find the beginning of the single tax doc¬ 
trine. If any one thing can be considered the key-note of their plan of social 
reform it is the last. 

When we fit the laissez faire doctrine into their natural-order concept it 
is readily seen that it meant something different from merely a policy of 
inaction on the part of the government. It meant rather a policy of govern¬ 
mental action in harmony with naturalism. In fact they did look to the 
government for positive action in the direction of their plan of social reform 
through taxation. The theory was that if the government would set itself 
correctly in harmony with the divinely ordained order, an order which the 
king and his court, in the opinion of the Physiocrats, might easily discover by 
self-analysis, the social problem would be solved. The social order was not, 
as taught by Adam Smith, a self-realizing order, but it had to be realized in 
the action of the king and his subjects much as the principles of musical 
harmony have to be conformed to by a band-master and the members of the 
band. The king had to submit to the principles of the natural order as much 
so as his subjects. Philosophy of this kind is not startling to us today, for 
at this time all governmental agencies must conform to recognized legal 
principles. But the subjection of the king to any other will than his own 
was somewhat foreign to the mind of the pre-revolutionary French monarchs. 

The introduction of laissez faire, even as explained by the Physiocrats, 
would have meant a radical change in policy, therefore, with regard to gov¬ 
ernmental interference in private affairs. The intricate regulations of mer¬ 
cantilism would have to be torn asunder. International free trade would 
become established, and a number of other departures equally as drastic, but 
the most urgent change was in connection with the tax system. Everyone 
who has even casually studied the burden of taxation in France at that time 

of the agriculturalists. The 2 milliards, in short, return to their starting-point. Adding the 
milliard already paid by the landed proprietors to the 2 milliards’ worth of products unsold, 
the total of 5 milliards is replaced in the hands of the productive class, and the process goes 
on indefinitely.” Gide and Rist: History of Economic Doctrines.” (pp. 19-20). 

It must have been their ability to take five milliards and divide them among three classes 
and give each class two milliards that fascinated the Physiocrats. What they were observing, 
had they been accurate in their description, was nothing more than the familiar capital turn¬ 
over which pervades the economic order of our times. 



THE CONCEPT OF ECONOMIC LAWS 


45 


cannot help having been impressed by the grinding burden of taxation on the 
peasants. Now, the Physiocrats showed this burden to be an influence in vio¬ 
lation of the principles of the natural order. The fact is, they demonstrated, 
through their tableau econotnique, that the taxes, of necessity, came out of 
the net product. By hypothesis, the peasants and artisans had incomes meas¬ 
ured by their means of existence. Regardless as to where the tax was placed, 
it had ultimately to come out of the net product. They contended, therefore, 
that all other forms of taxes should be abolished except a tax on land, and 
that it should be paid by the landed proprietors. Here we had the first 
appearance of the single tax doctrine—a doctrine that has received a great 
deal of attention during the nineteenth century. 

If the Physiocrats had been representatives of the poor classes their con¬ 
clusion would not have been surprising. But they in fact moved in the best 
circles. "In a word, Physiocracy became the rage. All this may seem strange 
to us, but there are several considerations which may well be kept in view. 
The society of the period, raffine and licentious as it was, took the same 
delight in the 'rural economy’ of the Physiocrats as it did in the pastorals of 
Trianon or Watteau. Perhaps it gleaned some comfort from the thought of 
an unchangeable 'natural order’, just when the political and social edifice 
was giving way beneath its feet. It may be that its curiosity was roused 
by that terse saying which Quesnay wrote at the head of the tableau eco- 
nomique: 'Pauvres paysans, pauve royaume! Pauvre royaume, pauvre roi!’ 
or that it felt in the words the sough of a new breeze, not very threatening 
as yet, but the forerunner of the coming storm.” (Gide and Rist: Hist, of 
Econ. Doctrines , p. 5.) 

But in spite of the cleverness of the Physiocrats in maintaining their 
position while they agitated for a change which meant the subordination of 
the proprietors, in spite of their ability to win the admiration for their 
philosophy, they failed when it came to securing the reforms for which they 
stood. It has been calculated that the income to the proprietors at the time 
was about two milliards francs—that amount being attributed to them in the 
tableau economique. A tax of thirty per cent, of the net product has also 
been calculated to be the amount necessary to have balanced the accounts of 
the French government. Lifting that burden from the peasants and placing 
it on the proprietors might conceivably have done the trick and staved off 
the Revolution. But the landlords did not look with favor upon the matter 
of shouldering such a heavy burden. The Physiocrats’ demonstration that 
they were carrying it anyway was not sufficiently convincing to them to 
induce them to change their attitude of opposing the reform. If they could 
look back now and contemplate the consequences of their obstinacy what 
would their reaction be? 

Gide and Rist call attention to the fact that if the Physiocrats were 


46 


THE EXPANSION OF ECONOMIC CONCEPTS 


writing today they would attribute the net product to the big capitalists. 
We have in them a group of men living in ease and luxury not materially 
different from the landed proprietors of the pre-Revolutionary France. This 
analogy may even be extended, for the economists of today are alike unani¬ 
mous in condemning certain arrangements connected with the capitalistic 
order. That is especially striking when we consider the matter of the bearing 
of the protective tariffs on international trade. We are much inclined to 
criticise the foolhardiness of the landed proprietors in France for not taking 
the advice of the Physiocrats and warding off the catastrophe of the French 
Revolution. The business interests which survive under the protective tariffs 
today assume very much the same attitude toward the advice of modern 
economists that the landed proprietors took to the Physiocrats! 

Adam Smith’s Doctrine of Spontaneity. —Adam Smith came very 
little nearer to the concept of economic laws than did the Physiocrats. His 
doctrine of the spontaneity of economic institutions, nevertheless, marked a 
significant advance over the Physiocratic concept of the natural order. In 
spite of the failure to develop any clear-cut economic laws, Smith’s doctrine 
of spontaneity, to this day, in no small way, pervades economic analysis. 
Without it an appreciation of the nature of economic laws is quite impos¬ 
sible. Because of that fact a brief synopsis of Adam Smith’s system of eco¬ 
nomics is desirable. 

Since the keynote of the system is the doctrine of spontaneity, we shall 
explain that first. In contrast with the Physiocratic natural order, which 
had to be realized and consciously followed, Smith taught that the economic 
order is a self-realizing one. 

“The present aspect of the economic world is the result of spontaneous 
action of millions of individuals, each of whom follows his own sweet will, 
taking no heed of others, but never doubting the ultimate result. The noble 
outlines of the world, as we know it, have been traced, not by following a 
plan issuing complete from the brain of an organizer and deliberately carried 
out by an intelligent society, but by the accumulation of numberless deeds 
designed by a crowd of individuals in obedience to an instinctive force 
wholly unconscious of the work which it was encompassing.” (Gide and 
Rist: Hist, of Econ. Doctrines, p. 69.) 

It was this thesis of spontaneity that gave Smith’s philosophy such an 
appealing note. “If a nation could not prosper without the enjoyment of a 
perfect liberty and perfect justice, there is not in the world a nation which 
could ever have prospered. In the political body, however, the wisdom of 
nature has fortunately made ample provision for remedying many of the 
bad effects of the folly and injustice of man; in the same manner as it has 
done in the natural body, for remedying those of his sloth and intemper- 


THE CONCEPT OF ECONOMIC LAWS 


47 


ance.” (Wealth of Nations, Cannan’s edition, Vol. II, p. 172.) The order 
was thus, not only natural and spontaneous, but it was entirely good. 

Spontaneity was the basis of Smith’s whole system of economics. The 
most outstanding precept growing out of it, and that which was the by¬ 
word of his immediate successors, was the contention that self-interest and 
social interest are in accord. The individual’s own inclination to follow his 
self-interest automatically promoted social interest. This assumption, which 
has since been shown to be fallacious, was the starting point of each of his 
other great precepts. It is not too much to say that the whole of the struc¬ 
ture of Adam Smith’s economics in one way or another reverted to the 
assumption of the reconciliation of self-interest to that of society as a 
whole. Fortunately the doctrine of spontaneity of economic institutions is 
separable from that of self-interest, for the former has done a more lasting 
service. The orthodox classical economist accepted both propositions. In 
modern economic analysis the latter proposition has been rejected as a per¬ 
manent and invariable fact, whereas the principle of spontaneity is essential 
to the correct understanding of economic laws. The concept of the economic 
equilibrium, without which many economic theses would be unintelligible, 
is certainly a survival of Smith’s doctrine of spontaneity. 

Let us see how he worked the doctrine into each of his major proposi¬ 
tions regarding the production of wealth. 

Division of Labor .—The quotation which best shows the spontaneity 
concept in relation to the division of labor is the following: 

"Man has almost constant occasion for the help of his brethren, and it is 
in vain for him to expect it from their benevolence only. He will be more 
likely to prevail if he can interest their self-love in his favour, and show 
them that it is for their advantage to do for him what he requires of them. 
Whoever offers to another a bargain of any kind, proposes to do this: Give 
me that which I want, and you shall have this which you want, is the 
meaning of every such offer; and it is in this manner that we obtain from one 
another the far greater part of those good offices which we stand in need of. 
It is not from the benevolence of the butcher, the brewer, or the baker that 
we expect our dinner, but from their regard to their own interest. We 
address ourselves, not to their humanity, but to their self-love, and never 
talk to them of our own necessities, but of their advantages.” (Wealth of 
Nations, Cannan’s edition, Vol. I, p. 15.) 

And further: this "certainty of being able to exchange all of that surplus 
part of the produce of his own labour, which is over and above his own con¬ 
sumption, for such parts of the produce of other men’s labour as he may have 
ccasion for, encourages every man to apply himself to a particular occupation, 
and to cultivate and bring to perfection whatever talent or genius he may 
possess for that particular species of business.” {Ibid. Book I, Chapter 4.) 


48 


THE EXPANSION OF ECONOMIC CONCEPTS 


Thus there is at work in society a force which impels each person auto¬ 
matically to seek the job for which he is best fitted, thus better serving his 
own needs and the needs of others. 

A further development of the same principle brings out the division of 
tasks in the manufacturing of any particular article. By that process the 
output is multiplied many times beyond what one man could do during the 
equivalent period of time. In this connection came the famous illustration of 
the manufacture of pins. 

Origin of Money .—A more interesting application of the doctrine of 
spontaneity appears in Smith’s theory of the origin of money. Although the 
date of the first coinage is known fairly well, the same cannot be said of 
the origin of money, for coinage and money have to be distinguished. Adam 
Smith’s theory in this regard is as good as any until such time as clear proof 
of the origin of the use of money has been discovered. He stated that the 
use of money developed from the breakdown of barter—particularly because 
of the difficulty of equalizing values in barter. 

"In order to avoid the inconveniency of such situations, every prudent 
man in every period of society, after the first establishment of the division 
of labour, must naturally have endeavoured to manage his affairs in such a 
manner, as to have at all times by him, besides the peculiar produce of his 
own industry, a certain quantity of some one commodity or other, such as 
he imagined few people would be likely to refuse in exchange for the produce 
of their industry.” {Ibid. Book I, Chap. 4, p. 24.) And Gide and Rist add, 
"Money is thus the product of the simultaneous though not concerted action 
of a great number of people, each obeying his personal inclination. The inter¬ 
vention of public authority is much later, and its object is merely to guaran¬ 
tee by means of a design the weight and purity of such coins as are already 
in circulation.” (p. 71.) Added evidence of the accuracy of Smith’s theory 
of the origin of money is the fact that different commodities have been 
chosen by widely separated tribes to serve as money. This fact is explainable 
by the fact that the common preference of different tribes has been different. 

Explanation of Prices .—As we shall see later Smith was baffled by the 
phenomenon of normal prices. He did, nevertheless, give a fair explanation of 
market prices through the application of his doctrine of spontaneity. 

"The quantity of every commodity brought to market naturally suits 
itself to the effectual demand. It is the interest of all of those who employ 
their land, labour, or stock, in bringing any commodity to market, that the 
quantity never should exceed the effectual demand; and it is the interest of 
all other people that it never should fall short of that demand.” {Ibid. p. 59.) 

"When the quantity of any commodity which is brought to market falls 
short of the effectual demand, all of those who are willing to pay the whole 
value of the rent, wages and profit, which must be paid in order to bring it 


THE CONCEPT OF ECONOMIC LAWS 


49 


thither, cannot be supplied with the quantity which they want. Rather than 
want it altogether, some of them will be willing to give more. . . . 

"When the quantity brought to market exceeds the effectual demand, it 
cannot be sold to those who are willing to pay the value of rent, wages and 
profit, which must be paid in order to bring it thither. Some part must be 
sold to those who are willing to pay less, and the low price which they give 
for it must reduce the price of the whole.” {Ibid. pp. 5 8-59.) 

Not a great deal of refinement of language would be necessary to make 
the above statements an acceptable description of the balancing of the supply 
schedule against the demand schedule in the determination of market prices. 
But Smith was much further from solid ground in his effort to explain nor¬ 
mal prices. His term "natural price” relates, of course, to the same thing 
that is meant today by the expression "normal price.” He saw that the 
market price tended to fluctuate above and below the "natural price”. But 
his explanation of natural price was confused. In one place it is accounted 
for by the amount of labor necessary for production, and in another it 
includes the whole of the costs of production. Between the two he failed 
to make a final choice. Further than that he did not go, and, of course, never 
sensed the complications of modern economic analysis which appear in the 
concept of the representative firm, and in the theory of changing normals. 

The Creation of Capital .—A similar doctrine was advanced by Smith 
regarding the source of capital. Considerable refinement of the doctrine that 
savings is the source of capital has appeared since Smith, but orthodox econo¬ 
mists still consider saving the source of capital. The proposition which Adam 
Smith developed remains substantially the same with regard to saving as the 
source of capital. It is a well-known fact that Smith was considerably influ¬ 
enced by Mandeville’s Fable of the Bees in the writing of his study of the 
Wealth of Nations. His theory of the creation of capital certainly bears an 
analogous import. He thought of capital as being continually increased by 
the impulse to save—to lay up something for a rainy day or to take care of 
one’s family. Individuals impelled by self-interest involuntarily built up a 
social fund available for loans, much as bees in the hive store up honey for 
the benefit of the colony. It is the surplus concept and not the self-interest 
impulse, however, that shows the resemblance to bees, for no greater example 
of complete self-sacrifice to the interest of the colony can be found than that 
of the honey-bee. 

"Whatever a person saves from his revenue he adds to his capital, and 
either employs it himself in maintaining an additional number of productive 
hands, or enables some other person to do so, by lending it to him for an 
interest, that is, for a share of the profits. As the capital of an invidual can 
be increased only by what he saves from his annual revenue or his annual 
gains, so the capital of a society, which is the same thing as that of all 


50 


THE EXPANSION OF ECONOMIC CONCEPTS 


individuals who compose it, can be increased only in the same manner.” 
(Ibid. Book II, Chapter III, p. 320.) 

In this, as in other matters, Smith left a great deal unsaid. It is readily 
seen that Smith was merely giving an explanation of the source of capital. 
The connection between this and the interest rate and the more complicated 
consideration of the determination of the interest rate itself remained for 
later authorities to consider. 

Free Trade .—The doctrine probably more nearly universally associated 
with Adam Smith than any other—that of free international trade—also had 
its basis in his concept of spontaneity. Smith, in fact, developed very few of 
the arguments which are now advanced in defense of free trade. To be 
accurate, he contributed'“bnly one substantial argument against the protec¬ 
tive tariff. That one, however, had its basis in a strange misapplication of his 
doctrine of spontaneity. Governmental interference with international trade 
prevented capital from automatically flowing into those trades which would 
yield the greatest return. 

"Every individual is continually exerting himself to find out the most 
advantageous employment for whatever capital he can command. It is his 
own advantage, indeed, and not that of society, which he has in view. But 
the study of his own advantage naturally, or rather necessarily leads him to 
prefer that employment which is most advantageous to society . . . 

"To give the monopoly of the home market to the produce of domestic 
industry, in any particular art or manufacture, is in some measure to direct 
private people in what manner they ought to employ their capitals, and must 
in almost all cases be either a useless or a hurtful regulation. If the produce 
of domestic industry can be brought there as cheaply as that of foreign indus¬ 
try, the regulation is evidently useless. If it cannot, it must generally be hurt¬ 
ful. It is the maxim of every prudent master of a family, never to attempt 
to make at home what it will cost him more to make than to buy. The 
tailor does not attempt to make his own shoes, but buys them of the shoe¬ 
maker. The shoemaker does not attempt to make his own clothes, but employs 
a tailor. The farmer attempts to make neither the one nor the other, but 
employs the different artificers. All of them find it for their interest to 
employ their whole industry in a way in which they have some advantage, 
or what is the same thing, with the price of that part of it, whatever else 
they have occasion for.” (Vol. I, pp. 419-22, Wealth of Nations , Cannan’s 
edition.) 

In this connection Smith explained his famous, but erroneous, hierarchy 
of the investment of capital. He was loyal to his theory of the peculiar part 
taken by nature in agricultural production; yet because of that fact it will 
not stand the test of careful analysis. According to this scheme capital flows 
into agriculture first, then into industry, after that into wholesale trade. 


THE CONCEPT OF ECONOMIC LAWS 


51 


and then to retail trade. Wholesale trade was subdivided into domestic and 
foreign, the latter being of secondary importance to the former. In further 
analysis of these relationships Smith became more and more confused. 

The extended summaries here given have related to those portions of the 
systems of Adam Smith and the Physiocrats that came nearest to the concept 
of economic laws. The nearest approach of all appears in Smith’s description 
of the behavior of forces in the determination of market prices. But even 
that—the law of supply and demand—lacked the exactitude necessary to a 
scientific law. It lacked very much the refinements given it by later classical 
economists. Smith and the Physiocrats, both, were grasping after economic 
laws, but the laws as such remained remote. We even look in vain for a 
clearly defined economic law in the works of J. B. Say, although his law of 
outlets, or markets, stopped little short of the goal. 

The Discovery of Economic Laws. —If each economic law at its dis¬ 
covery—and for that matter continuously thereafter—had created the sen¬ 
sation that was created by the first, one hesitates to think what would have 
been the consequences to the science of economics. The fact is that a whole 
new science—that of biology—has developed from reflections begun with 
the Malthusian postulate. Since one looks in vain in economic literature for 
propositions which contain all of the earmarks of scientific laws before the 
appearance of the Malthusian law of population, and since the so-called Mal¬ 
thusian theory does conform to the tests of a scientific law, we must con¬ 
clude that the Malthusian law of population was the first clearly stated 
economic law, after the rise of the science of economics* 

The underlying thought of the Malthusian postulate has undergone con¬ 
siderable modification since it was first presented, and many of the support¬ 
ing arguments presented by Malthus hardly stand the test of a modern 
analysis. But the Malthusian thesis has enough of soundness in it to be held 
as a statement of a scientific truth. 

In another place it will devolve upon us to show the relation of the Mal¬ 
thusian thesis to the law of wages. Since, however, we find it in the first 
economic law, it behooves us to state at this time the general aspects of the 
law. 

Pre-Malthusian assumptions with regard to the growth of population 
were for the most part far from scientific. Some of them, however, showed 
a great reliance on science. Illustrations of the pre-Malthusian attitude are 
found in the works of Godwin and of Condorcet. Godwin (1793) who was 
in fact an anarchist and a doctrinaire, looked on the future with undaunted 
optimism. With the disappearai>ce of government and the abolition of the 
desire for profits he expected life in this world to become supremely attrac- 

* Gresham’s law originated prior to the science of economics. 



52 


THE EXPANSION OF ECONOMIC CONCEPTS 


tive. When he viewed the question of the effect of such a pleasant world on 
the growth of population he stated that reason would prove as powerful in 
controlling the sex instinct as in controlling profits. Similarly Condorcet, 
writing in France in 1794, just before being guillotined, displays the same 
confidence in science at least to postpone death indefinitely. But where would 
all the people live? His answer was that either reason would be able to 
prevent the inordinate increase or science would find the means of their 
support. (Gide and Rist. Hist, of Econ. Doctrines, pp. 121-122.) Such 
answers were, of course, merely an evasion of the issue. Malthus dared to face 
the problem squarely. 

He thought that he saw in the rate of increase of the population of the 
North American continent evidence of a natural tendency with regard 
to that increase. He found that the population there had doubled itself each 
twenty-five years. His conclusion was, therefore, that population tended to 
double itself every twenty-five years, and hence tended to increase geometri¬ 
cally. From this he began to inquire what the consequences must be regard¬ 
ing the relation between this rate of increase of population and the rate of 
increase of means of subsistence. He was fully aware that plants and animals 
using food products tended to increase geometrically also. He was not con¬ 
cerned about that. His problem was further to ascertain what to exoect 
with regard to man's ability to exact from the limited supply of land an 
increase in means of subsistence. The records show that during the 120 
years preceding man had been able to increase the average yield per acre of 
grain hardly more than one bushel for each twenty-five years. The conse¬ 
quence was—geometrical increase in population and arithmetical increase 
in the means of subsistence. In a very few centuries man would be facing the 
problem of not being able to provide for his own existence. In doing this 
Malthus conformed to our test of a scientist. He observed a phenomenon, 
formulated his hypothesis, and without prejudice sought for data and drew 
his conclusion. The conclusion which he reached has for more than a cen¬ 
tury plagued the moralist and puzzled the economist. 

With the appearance of the Malthusian law of population economics took 
on a much more sombre hue. Man can but feel his helplessness in the face of 
established scientific principles. From that event we must now trace the 
emergence into the modern concept of economic laws. 

Economic Laws as Scientific Laws.— (1) The Later Classical Concept 
of Economic Laws. —After Malthus, David Ricardo understook to work over 
political economy. He desired more to fill in the gaps which he thought 
needed filling in in Adam Smith’s Wealth of Nations than he did to build 
the science anew. When his book appeared, however, it contained many 
contributions. He accepted without question the Malthusian law of popula- 


THE CONCEPT OF ECONOMIC LAWS 


53 


tion and proceeded to build around it a whole galaxy of economic laws. All 
of these bred pessimism just as the Malthusian law itself. Because of the help- 
lesness of man’s outlook in the face of these laws, which were considered 
by Ricardo and his followers as infallible as any of the physical laws, the 
later Classical, particularly Malthus and Ricardo—are called pessimists. 
Carlyle somewhat later even dubbed the science the "dismal science.” 

Owing to the fact that throughout this work the respective laws will 
receive treatment in their places it will be unnecessary to take them up in 
detail here. The laws of particular interest which grew out of the Malthusian 
theory were: the law of diminishing returns, the law of rent, the so-called 
iron law of wages. Supplementary to these was Ricardo’s concept of the 
stationary state, the labor theory of value, and the law of comparative costs 
in international trade. 

With the possible exception of the law of diminishing returns, every one 
of these laws has had to be materially corrected. But very little advance was 
made in the concept of economic laws during the first half of the nineteenth 
century. By the time of the appearance of John Stuart Mill’s treatise political 
economy had attained a powerful hold on the minds of men of affairs. Mill 
became a champion of economic laws as the concept was presented by his 
predecessors. "To say that political economy is a 'dismal science’ because it 
shows that certain laws may have unfortunate results is as absurd as it would 
be to call physics a 'dismal science’ because lightning kills,” was his retort 
to the stigma placed by Carlyle on the science. 

But the science of political economy after Ricardo did fall into a rut. 
As is usually the case in circumstances of the kind, the exponents of the 
science were least of all able to see that any further progress was necessary. 
The economic laws had been formulated and explained. It was the duty of 
man to recognize the existence of these laws and bring his conduct into con¬ 
formity with them. 

There developed, thereupon, a very interesting effort to popularize those 
laws. The science being, as they thought, now constituted, the main thing 
that remained to be done was to get the principles so stated that even young 
people could comprehend them. As a result several books were published 
to that end, notably, in 1816, Mrs. Marcet’s Conversations on Political 
Economy, and in 1832-34, Miss Martineau’s Illustrations of Political Economy 
(nine volumes containing thirty stories), and MacWickar’s First Lesson in 
Political Economy for the Use of Elementary Schools. According to Mac- 
Wickar "The first principles of economics are mere truisms which the 
children might well understand, and which they ought to be taught. A 
hundred years ago only savants could understand them. Today they are the 
commonplaces of the nursery, and the only difficulty is in their too great 
simplicity.” (Gide and Rist: History of Economic Doctrine, p. 349). So 


54 


THE EXPANSION OF ECONOMIC CONCEPTS 


popular did political economy become that "distinguished ladies before en¬ 
gaging a governess for their children inquired about her competence to teach 
political economy.” {Ibid, note 3, p. 119.) 

Confidence of infallibility is always a dangerous security. It proved to be 
so for the Classical economists. There is, however, a remarkable parallelism 
between the history of economics during the nineteenth century and its 
history during the twentieth century. Just one hundred years ago political 
economy was finding its place in the elementary schools with the assumption 
that the problem of simplification was quite possible. Likewise during the last 
few years a number of texts prepared especially for high school use have 
appeared. We are even handed conversational presentations of principles sup¬ 
posed to be accurate presentations of economic phenomena. (Foster and 
Catchings’ "Road to Plenty ” 1929). This would be very well were it not 
for the fact that there are so many economic phenomena yet to be under¬ 
stood. Almost none of the economic laws had as yet been accurately stated. 
Since the time of John Stuart Mill the study has undergone a great trans¬ 
formation. Our problem now is to show how this has come about, how those 
laws which once were known as fundamental laws have come to be known 
as scientific laws. 

(2) The Effort of the Historical School to Reconstitute the Science of 
Economics in Conformity with the Inductive Method .—An allusion to the 
attack made by the Historical School of economists on Classical economics 
has already been made in the introductory chapter to this study. It devolves 
upon us now to show wherein the Historians failed to comprehend the 
Classical concept of economic laws. In spite of the shortcomings of the 
Historians it was largely because of their challenge that the science was 
lifted out of the rut into which it had fallen. The story is an old one, but it 
is essential to know it before one can fully appreciate the nature of economic 
laws as they are now understood. 

The Historians centered on four points which they considered basic to 
Classical economics. They were the unchangeable nature of economic laws, the 
Classical homo economicus , or economic man, the universality of economic 
laws, and the employment of the deductive method of reasoning. 

The Classical economists thought of economic laws as natural laws. To 
their mind they were fixed and determinate, as much so as physical or 
mathematical laws. It was as futile for a legislature to attempt to modify 
them as to pass a law requiring that the circumference of a circle be exactly 
three times the diameter. It was that point which was attacked by the 
Historians. They contended that instead of being fixed and determinate, 
economic laws might not in fact be as they were explained by the Classical 
economists. The problem was rather that of discovery of economic laws 
by a meticulous analysis of history. Not all of the Historians presented the 


THE CONCEPT OF ECONOMIC LAWS 


55 


same point of view. For instance, Wilhelm Roscher contended merely that 
the economic laws as explained should be submitted to verification through 
historical research. Bruno Hildebrand doubted whether or not any of the 
content of the laws as explained would stand the test of history. His desire 
was to resort to history for the purpose of discovery of the laws. In other 
words, Hildebrand thought that the whole structure of political economy 
should be placed on a new foundation. Karl Knies even doubted the existence 
of economic laws. Knies’ point of view would have resulted in the complete 
destruction of political economy. Probably, the only thing worth while would 
have been economic history. Gustav Schmoller, and his followers, however, 
writing somewhat later than the previously mentioned authorities, returned 
to the point of view advanced by Hildebrand and set out to execute the 
great mission of rebuilding the science by means of the inductive method. 
We see, therefore, that not all of them presented the same point of view 
with regard to the discovery of economic laws, but they were agreed in 
opposing the categorical statement of the laws as made by Ricardo and his 
followers. They at least doubted that the laws as they had been set forth 
were necessarily true economic laws. 

With regard to the second point made by the Historians, they accused 
the Classicals of being too much slaves to their concept of the economic 
man. Man was considered, they asserted, as always prompted by self-interest, 
seeking the maximum amount of satisfaction with the minimum expenditure 
of effort. They accused the Classicals of having a crude phychology, one 
based simply on egoism. In effect they paraphrased Shakespeare by saying 
that there were more things in heaven and earth than were dreamed of in 
the philosophy of the political economists. 

With regard to their accusation relating to the universality of economic 
laws, "The Historians held that the greatest error committed by Smith and 
his followers was the inordinate stress which they laid upon the universality 
of their doctrines . . . The belief of the Anglo-French school, according 
to their version of it, was that the economic laws which they had formulated 
were operative everywhere and at all times, and that the system of political 
economy founded upon them was universal in its application. The Historians, 
on the other hand, maintained that these laws, so far from being categorically 
imperative, should be regarded always as being subject to change in both 
theory and practice.” (Gide and Rist, p. 390.) 

As already stated, the major point—that which was the basis of all of the 
other contentions of the Historians, was that the truly scientific method was 
the inductive method. According to them, therefore, there was needed a 
reconstruction of political economy according to that method. If they could 
have accomplished their objective, economics would have become entirely 
subordinate to history. Chairs of political economy in the colleges and uni- 


56 


THE EXPANSION OF ECONOMIC CONCEPTS 


versities would have disappeared, and whatever political economy was taught 
would have been taught in the departments of history. 

By way of digression it should be mentioned that a point of view 
analogous to that of the Historians was sponsored by Comte. August Comte s 
positivism really served to give to the Historians a more attractive objective 
even than that which they created for themselves. According to Comte, 
history should be employed as an "organon of social science. 'Social research,’ 
says Ke, 'must be based upon a sane analysis of the all-round development 
of the best of mankind up to the present moment, and the growing pre¬ 
dilection for historical study in our times augurs well for the regeneration 
of political economy’ . . . 

"Comte speaks of Historical method as an attempt to establish in 
ascending or descending series the curve of each social institution, and deduce 
from its general outlines conclusions as to its probable growth and decline 
in the future.” (Ibid. 404-5.) 

Comte’s task, although more inordinate than that undertaken by the 
Historians, was more appealing. What could be more scientific than to plot, 
from the past, curves of social institutions? Assuming, as he seems to do, 
that history is made up of continually recurring cycles, all that one would 
need do, after the task had been completed, would be to locate any particular 
occurrence on the curve of the institution to which it belongs, and a clear 
view could be secured of what to expect in the future. 

As a result of Comte’s thesis, if it could have been made effective, both 
political economy and history would have become subordinated to sociology. 

With regard to the concept of economic laws, it is the purpose here to 
show that during the third quarter of the nineteenth century the science 
of economics encountered a terrific jolt. In fact it came near losing its 
standing as an independent science. When it recovered, however, it did so 
with a freshness and vigor almost if not quite characteristic of a new science. 

(3) Karl Menger’s Defense of Classical Political Economy .—The restora¬ 
tion of political economy to the position of respect which it now occupies 
is probably traceable more specifically to Karl Menger’s brilliant defense of 
Classical concepts against the attacks of the Historians than to any other 
influence. It need hardly be said that the job undertaken by the exponents 
of the historical point of view was impossible of performance. The effort 
had to break under the strain. But the breakdown of the effort of the His¬ 
torians could not have in and of itself restored the science to its former 
commanding position. The need was for some one to show convincingly 
wherein the philosophy advanced by the Historians was untenable. The 
further need was to show what it was in Classical economics that deserved 
criticism. The first of these—that of showing wherein the Historians’ attacks 
on the Classical were untenable—was the work of Karl Menger, in a study 


THE CONCEPT OF ECONOMIC LAWS 


57 


of the method of social science published in 1883 . The second—that of 
laying the foundation for the correction of classical economics—was under¬ 
taken by Menger and several others of his contemporaries. It behooves us at 
this point to summarize Menger’s arguments directed at the Historians. 
Thereupon will follow the major points of just criticism of classical economics 
—defects which had to be removed before the study could be lifted out of 
the rut into which it had fallen. 

Menger proceeded to show that the criticisms were based on an in¬ 
accurate interpretation of the authorities. Regarding the assumption that the 
relativity of economic laws would separate them from the way of treating 
laws of other sciences, Menger showed that all scientific laws are relative— 
or provisional. "They are the product of man’s thought and advance with 
the development of his intelligence.” Why, therefore, was it necessary to 
consider the conclusions of the early economists as entirely erroneous? Why 
not approach them rather as efforts to discover the truth? In fact, as Menger 
showed, the classical economists would be the first to admit that an attempt 
must be made to adapt economic legislation to varied conditions of time and 
place. The mistake of the Classicals was that they had advocated the universal 
adoption of laissez faire . By removing the laissez faire doctrine from the 
classical concept of economic laws we secure a concept not materially dif¬ 
ferent from that of other scientific laws. 

Menger further showed that the Classicals were fully aware of the fact 
that man’s behavior is frequently prompted by other motives than that 
of self-interest. Mill had said, "The motive that suggests the separation of 

this portion of the social phenomenon from the rest ... is that they do 

mainly depend at least in the first resort on one class of circumstance only; 
and that even when other circumstances intervene, the ascertainment of the 
effect due to the one class of circumstances alone is sufficiently intricate 
and difficult business to make it expedient to perform it once and for all 

and then allow for the effect of modifying circumstances.” (Quoted in G. 

and R., p. 392 .) In other words, economists have the right to examine the 
behavior of man in the light of the promptings of one of his motives— 
the most evident so far as economic behavior is concerned—and then to 
make corrections in the light of modifying circumstances. Thus the charge 
of egoism made by the Historians was deprived of its sting. 

But even in this connection Menger showed that the classical economists 
deserved to be criticised. The assumption that self-interest and social interest 
were in conformity with each other had been challenged already and was 
open to serious question. Further, the behavior of the economic man—as 
described particularly by Ricardo—was the behavior of a creature of the 
imagination. The Classicals needed to be forced out of their closets so that 
they might verify their conclusions in the thickness and complexities of 


58 


THE EXPANSION OF ECONOMIC CONCEPTS 


actualities. The Historians’ challenge, therefore, was a good one but mis¬ 
directed. 

Viewed from this distance the attack made by the Historians on political 
economy is best considered as one of many efforts of different interests to 
bend the science of economics to their own end. Most of these efforts have 
broken under the strain, having neither bettered themselves nor the science 
of economics. The attack made by the Historians was constructively bene¬ 
ficial to the study of history, for their effort to discover economic laws 
prompted an accuracy of research never previously known to historical writ¬ 
ings. It was also beneficial to political economy because it forced attention 
on defects in the treatises so that a more careful presentation of the subject- 
matter of economics resulted. 

It was in this connection that Menger showed that the Classical needed 
to be criticised not for the me of the deductive method but for the abuse 
of that method. They had started with insufficient premises. Even when the 
premises were correct they frequently jumped at conclusions. No one was 
willing to defend their hasty generalizations. But that was quite a different 
thing from abandoning all of their work simply because they had employed 
the deductive method of reasoning. 

There followed an extended controversy as to whether the deductive 
or the inductive method of reasoning is the scientific method. Happily this 
period of controversy is now passed. No longer is there any dispute among 
mature scientists with regard to what constitutes the scientific method. 

The result of it all was that a new life was breathed into the science 
of economics. There followed in Menger’s wake a number of master in¬ 
tellects who set to work to fill in the gaps so clearly evident in classical 
economic literature. With that the science has made tremendous strides in 
the direction of the goal of a well constituted science. 

(4) Economics as a Science .—Even before the rise of the neo-classical 
economists there were signs of weakening in the ranks of the naturalistic 
concept of economic laws. John Stuart Mill, himself, had retreated from his 
position of complacent assurance of infallibility. The story of his recantation 
of the wages-fund doctrine is well known. Likewise he developed a much 
more conciliatory attitude toward social reform, and even toward socialism. 
"If, therefore,” said he, "the choice were to be made between communism 
with all its chances and the present state of society with all its sufferings 
and injustices; if the institutioh of private property necessarily carried with 
it as a consequence that the produce of labour should be apportioned as we 
now see it, almost in an inverse ratio to the labour—the largest portions to 
those whose work is almost nominal, and so in a descending scale, the re¬ 
muneration dwindling as the work grows harder and more disagreeable, until 
the most fatiguing and exhausting bodily labour cannot count with certainty 


THE CONCEPT OF ECONOMIC LAWS 


59 


on being able to earn even the necessaries of life; if this or communism 
were the alternative, all the difficulties great or small, of communism, would 
be but as dust in the balance.” ( Principles, Book II, chapt. 1, sec. 3.) 

In contemplating statements like that made by eminent Classical it 
should always be remembered that they did not consider the established 
order as exactly synonymous with the competitive order. The order of free 
competition was as much to be striven for as was communism. The Classicals 
were aiming at the former, an order which they assumed to be both superior 
to the established order and to comunism. 

Mill, nevertheless, did show, in his later life, a remarkable departure 
from the naturalism of the early Classicals. Yet his work in that regard did 
little toward the advancement of the concept of economic laws. He never 
took the extreme position of the socialists, nor even went to the extent of 
the Historians with regard to the concept of economic laws. He held, how¬ 
ever, that a distinction could be made between those laws which apply to 
production and the ones which apply to distribution. In the case of produc¬ 
tion he thought that natural laws still prevailed. But those laws which relate 
to distribution—wages, profits, and rents—were not "immutable laws against 
which the will of man can never prevail.” 

Although the distinction made by Mill does not stand in modern economic 
analysis, yet projected on that assumption Mill outlined a plan of social 
reform the points of which have really proved to be prophetic in import. 
The comprehension of the propositions advanced by Mill involve an apprecia¬ 
tion of several of the fundamental laws. A review of these points, therefore, 
must be postponed until an examination has been made of the concrete 
economic laws. 

It remains for us to show the contrast between the classical concept of 
economic laws and that of the neo-classicals. The neo-classical concept is the 
one which we present here as the accepted concept. 

The most outstanding change concerns casual relationship. Take as an 
illustration the change that has come in the statement of the law of demand 
and supply. The classical statement of the law was: "price varies directly 
with demand and inversely with supply.” In the revised statement of this 
law no such mathematical accuracy is assumed. Demand and supply are 
considered as much a function of price as price is a function of demand and 
supply. It is true that price is more passive than the other two forces, since 
that which operates to cause a change usually operates either through de¬ 
mand or through supply. But if for any reason price should become active— 
as it does in times of stress, or in times, of inflation—it too may act on 
supply and demand. If, for instance, the price should rise, due to a false 
rumor of a shortage of supply, the amount taken (the demand) would 
almost certainly fall off. There is further no reason to assume that the 


60 


THE EXPANSION OF ECONOMIC CONCEPTS 


variations follow any mathematical accuracy. A very small rise or fall in 
price may cause a tremendous decrease or increase in the demand, or the 
effect may in fact be very insignificant. Similarly a small increase in supply 
may cause a tremendous fall in price. In this connection has been developed 
the concepts of elasticity and inelasticity of demand. About all that the 
modern economist dares to say is that an increase or decrease in the supply 
or demand tends to produce a reverse effect on price. The extent of the 
variation is left for further analysis dependent upon many peculiarities of in¬ 
dividual commodities and services. 

Another interesting change has come with the analysis of the relation of 
the cost of production to value. The classical economists were very sure that 
the cost of production determined value. In most cases they thought of labor 
as synonymous with cost. They were careful to show that rent was a result 
of price, but they thought of the other costs as determining value—normal 
value, of course. The Neo-Classicals show that what the Classicals said of 
rent is also true of other costs. Value is as much a determinant of costs 
as costs are of value, for the factors which were the component of the cost 
had each a price. Consequently the statement that costs of production de¬ 
termine value is evidence of circular reasoning. The Neo-Classicals break 
through the vicious circle by showing that between cost of production and 
price "there exists a kind of equilabrating action in virtue not of any 
mysterious solidarity which subsists between them, but because the mere 
absence of equilibrium due either to dimunition or increase in the quantity 
of products sets up forces which tend to bring it back to a position of 
equilibrium. This interdependent relation, which is extremely important in 
itself, and upon which the Hedonists lay great store, is simply one example 
taken from among many where the value of one thing is just the function 
of another.” (Gide and Rist, p. 520.) 

In their explanation of distribution the Classical economists were more 
confused even than in the other points mentioned. "Bohm-Bawerk wittily 
remarks that the saying that wages are determined by the product of labour 
apparently only amounts to this—that what remains (if any) after the 
other co-operators in turn have their share is wages. Each co-partner in 
turn becomes a residual claimant and the amount of the residuum is de¬ 
termined by assuming that we already know the share of other claimants.” 
(Gide and Rist, p. 520.) 

For instance: "Let P equal the value of the product, and x, y and z 
represent wages, interest, and rent, respectively, then x -j-y -f- z = P, 
which is insoluble. 


THE CONCEPT OF ECONOMIC LAWS 


61 


"Nor does it seem more hopeful when written out thus: 

x = P — (y + z) 

y = P — ( X + Z) 

2 = *P — (x y).” (Gide and Rist, p. 521, note.) 

These illustrations are enough to show that the critical analysis of 
classical economics revealed important shortcomings. Truly there were many 
things in heaven and earth that they had not dreamed of. 

It is not the intention here to go deeply into the emendations, extensions, 
and corrections that have been made to classical economics. These will come 
out as we proceed with the study. It is hardly too much to say that political 
economy was not a science until after those corrections were made. With the 
corrections it has all the earmarks of a science. The laws as explained and 
proved are scientific laws in the same sense that we have scientific laws 
in other fields. There are, nevertheless, some things about the science that 
occasion special comment. 

(a) It is a Complex Science .—Professor Alfred Marshall has well stated 
this point as follows: 

"The natural sciences, and especially the physical group of them have 
this great advantage as a discipline over all studies of man’s action, that in 
them the investigator is called on for exact conclusions which can be verified 
by subsequent observations or experiment. His fault is soon detected if he 
contents himself with such causes and such effects as lie on the surface.” 
{Principles, p. 43.) 

But owing to the fact that errors in conclusions of students of economic 
phenomena are not evident on the surface of things, and to the further 
fact that economics deals with many variables, it has to be classed as a 
complex science. Practicaly all economic phenomena resemble the physical 
problem of calculating the oscillation of a weight suspended from the hand 
by a string into a mill-race when the hand itself is not steady. Each situation 
has to be analysed with an assumption of constancy which is known to be 
untrue. Allowance must be made for the variations from the assumptions 
when these variations themselves are irregular. Economics is, therefore, rightly 
called a complex science, for in these variations exist and are discoverable 
the economic laws. 

(b) Experiment is Impracticable. —The fact that man himself is a part 
of the phenomena which he is observing complicates the problem instead of 
simplifying it. He, so to speak, lives in his laboratory. This fact makes ex¬ 
periment well nigh impossible. Because of that fact the conclusions of 
economists are much less subject to verification than is true of the conclusions 
of the physical sciences. Professor Gide has well stated this point as follows: 
"The chemist, the physicist, and even the biologist (although the latter 


62 


THE EXPANSION OF ECONOMIC CONCEPTS 


encounters greater difficulties) can always take the phenomena that they 
wish to study, and subject them to artificially determined conditions which 
may be varied at will. In order, for instance, to study the breathing of an 
animal, they can place it under the bell-jar of an air-pump, and regulate the 
air pressure as they please. But the economist, even though he be also a 
law-giver, or an omnipotent despot, does not possess this power of experi¬ 
ment.” ( Principles , p. 15.) 

Yet, as Gide further states with regard to the existence and apprehension 
of economic laws: 

"The word law should suggest no other idea than that of a constant 
relation between certain facts, such as if one fact is given, the others ac¬ 
company it or follow it—as for example, the relation between the quantity 
of a commodity and its price, or between the price and the demand for it. 

"Moreover, it is exactly the same with physical laws. They also express 
nothing more than certain relations that are spontaneously established be¬ 
tween things—relations which can be called necessary ones only if certain 
foregoing conditions are fulfilled. Atoms of oxygen and hydrogen are not 
compelled to produce water; but if one atom of oxygen and two of hydrogen 
are brought together under certain conditions of temperature, pressure, etc., 
they will form water. Similarly, men are not obliged to buy and sell, but if 
a man disposed to sell meets a man disposed to buy, and if their offers are 
mutually acceptable, they will necesarily conclude a bargain.” (Ibid. p. 9.) 

This quotation is presented as an excellent statement of the currently 
accepted conception of an economic law. There is, at this time, no assump¬ 
tion that the laws are rigid and superior to legislative acts. There is, how¬ 
ever, still the assumption that economic laws are not capable of modification 
by acts of legislatures. But the legislature does have the power of obstructing 
the operation of a beneficent, or, for that matter, a malicious law, thus 
bringing into play the operation of forces which are either harmful or 
beneficial. It is highly desirable, therefore, that legislators—all men of affairs 
in fact—consider what, in obedience to the operation of whatever economic 
law their actions may set in motion, will be the consequences of their be¬ 
havior. This may seem to bring us back almost to the Physiocratic concept 
of the natural order. It is very much like it in its point of view. But the 
treatment made of the subject-matter is today far removed from that of 
the Physiocrats. The subject-matter of economics now retains as well the 
Smith doctrine of spontaneity, and in addition embraces much that these 
early writers never even imagined. 


CHAPTER IV. 


MARKET VALUE 

When first approached probably no economic concept seems more easily 
understood than that of value. It remains, however, very likely the least 
understood of all economic concepts. 

Before proceeding with our discussion of the expansion of the concept 
of value we need to prepare a background against which we can project 
the subject-matter. 

Let us assume that all goods and services which are produced for sale 
are brought to a central storehouse. At this storehouse let us suppose 
that they are paid for by means of orders on the storehouse for the things 
left there by other producers. Now let us examine the behavior of buyers 
and sellers. Were it not for the fact that we, ourselves, desired other goods 
more than those which we possessed we would not offer ours for sale. It 
is in connection with the amount of other goods that our own will secure 
in exchange for them that we discover the phenomenon of value. Owing to 
the fact that instead of exchanging these goods directly one for another, 
they must first be translated into orders on the storehouse—money—it is 
impossible to account for market value without accounting for prices. If, 
however, we will always remember that the transfer into terms of money 
is really nothing more nor less than an exchange of what we have for orders 
which will give us command of goods and services which other people are 
offering on the market, we shall better be able to find our way through the 
intricacies of the analysis of value. With this as a background let us proceed. 

A few points become immediately evident. Why, for instance, can wealth 
not be increased merely by the increase of the amount of money? In the 
answer to this question we see the distinction between the individual and the 
social concept of money. If the number of orders is increased clearly each 
order is merely worth less. Yet each individual is rich or poor in relation 
to the number of these orders he possesses. Wealth of the individual is in¬ 
creased mainly by bringing to the storehouse things which command a 
large number of orders. Here we have evident the fact that individual wealth 
and social wealth are controlled by different laws. We have already noted that 
individual wealth is a value phenomenon, whereas social wealth is merely 


63 


64 


THE EXPANSION OF ECONOMIC CONCEPTS 


a question of abundance. It is with this value phenomenon that we are now 
concerned. 

Even before the rise of the study of economics, considerable attention 
was given to the problem of market value. An interesting story could be 
made of the efforts of the baffled rulers during the ancient times and middle 
ages to handle the market-value phenomenon. The small comprehension 
of the complex principles controlling the production and sale of goods led 
them to strange measures. We shall, nevertheless, pass them up and begin 
our discussion with the effort of the Physiocrats to solve the riddle. 

The Bon Prix Concept. The following expression states concisely 
the Physiocratic concept of market value. In fact it might even be taken, 
as is true of many of the Physiocratic concepts, as an expression of the 
present-day popular concept of value. The statement is that ’'Abundance and 
cheapness are not wealth, scarcity and dearness are misery, abundance and 
dearness are opulence.” Here we have the Physiocratic "bon prix ” (good 
price.) 

The Relation of the Bon Prix to the Natural-Order Concept. —In its 
application to the natural-order concept the Physiocratic bon prix loses 
some of its naivete. Only if the price of agricultural products yielded a 
surplus over and above the cost of production could the net product be large. 
Hence for those engaged in agriculture abundance and dearness did mean 
opulence. In spite of their determined effort to do so, the Physiocrats were 
not entirely successful in separating the private from the social point of 
view in the consideration of wealth. When agricultural products were dear 
and abundant their producers were able to command in return for them 
a larger amount of other commodities. This, of course, tended to occur in 
spite of the fact that the Physiocrats failed to perceive that other activities 
than agriculture were in fact productive. If agricultural prices were high 
there was opulence among the proprietors, for the net product was large. 
The bon prix must have meant simply that. Being blind to the full compre¬ 
hension of the nature of the relation between production and distribution 
the Physiocrats stopped short of a clear statement of the concept of market 
value. 

Correction of the Bon Prix Concept. —Reference to our discussion of the 
nature of productive effort will be helpful in discovering the correction of 
the bon prix concept. It will be remembered that unless a distinction is made 
between wealth and value, invariably we encounter difficulties. It is due to 
the failure of the Physiocrats to make that distinction that they subscribed 
to the proposition made in their concept of the bon prix. 

No assumption is made that at the time of their writing they should be 
expected to have seen that distinction. Nevertheless the recognition of that 
distinction is fundamental to an accurate analysis of market value. 


MARKET VALUE 


6 5 


If we will take each clause and analyse it separately its economic in¬ 
accuracies will become evident. 

(1) "Abundance and cheapness are not wealth.” Individually it is true 
that if a person has an abundance of things he himself does not want and 
others are willing to buy them only at a price less than his expenses of 
production, abundance and cheapness are not wealth. Only in that sense 
can the assertion be given any meaning. Socially speaking wealth is impossible 
without an abundance of want-satisfying goods and services. The matter 
of price is of small importance. We might say that it is of no importance 
at all except in its bearing on a transition from one price level to another. 
If the total supply of orders on our imaginary storehouse is increased each 
order commands less and vice versa. Socially speaking, therefore, wealth and 
prices are independent of each other, except as one reacts on the other in 
periods of transition. Price phenomena are scarcity phenomena, whereas wealth 
phenomena relate to abundance. In a state of superabundance of wealth, 
values, i. e., prices, would fall to zero. Clearly, therefore, we cannot say 
that abundance and cheapness are not wealth and make any general ap¬ 
plication of the statement. 

(2) "Scarcity and dearness are misery” is not an inaccurate expression 
except in that it fails to recognize that dearness is not a necessary con¬ 
comitant of scarcity if the meaning of the word dearness is limited merely 
to a price relationship. The mere fact of scarcity does not necessarily mean 
high prices, for the very simple reason that the money supply—orders on the 
storehouse—may be relatively as scarce as goods in general. The expression 
is true, however, if it is taken simply to mean that scarcity relates to an 
increase in the intensity of our desires for goods over that of a previous 
occasion when goods may have been more abundant. In that sense scarcity and 
dearness are misery. 

(3) "Abundance and dearness are opulence” is an exact counterpart of 
the first clause. Individually it is true, but socially it is the reverse of the 
truth. If I carry to the storehouse an abundance of commodities for which 
a high price is received I am opulent for the very simple reason that the 
other commodities are cheap in terms of mine. But clearly it is impossible 
for every one to receive a high price for commodities if all commodities are 
abundant. As previously noted we find our way out of this dilemma in the 
distinction between wealth and value. But we find here a significant con¬ 
flict between individual and social interest. This conflict is responsible for a 
great deal of inconsistency in the attitude of producers in their desire to 
control the markets. 

We see, therefore, that in their effort to state the principle of market 
value the Physiocrats opened up a very fertile field of inquiry. In this, how- 


66 


THE EXPANSION OF ECONOMIC CONCEPTS 


ever, as is true of most of their concepts, the Physiocrats stopped short of 
the fundamental economic truth. 

Adam Smith and the Equilibrium of Supply and Demand. We 
shall see later that a theory of normal value can be imputed to the Physio¬ 
crats. Only by implication can that be said to be true of them. There was 
no suggestion of the oscillation of the- market value above and below the 
normal. The superiority of Adam Smith’s analysis of value over that of the 
Physiocrats is marked (1) by his description of the equilibrium of exchanges 
in the determination of market value, and (2) by the effort to discover 
the cause of the oscillation above and below what he called the natural 
price. In connection with the first of these Smith did a substantial piece of 
work. In connection with the second his discussion is highly confusing. We 
are concerned at this point only with the first. 

A few comments on this point were made in our chapter dealing with 
the subject of economic laws. (See page 67.) The following language is of 
significance here: "The actual price at which any commodity is commonly 
sold is called its market price. It may be either above, or below, or exactly 
the same with natural price. 

"The market price of every particular commodity is regulated by the 
proportion between the quantity which is actually brought to market, and 
the demand of those who are willing to pay the natural price of the com¬ 
modity, or the whole value of the rent, labour, and profit, which must be 
paid in order to bring it thither. Such people may be called the effectual 
demanders, and their demand the effectual demand; since it may be sufficient 
to effectuate the bringing of the commodity to market. It is different from 
the absolute demand. A very poor man may be said in some sense to have 
a demand for a coach and six; he might have to have it; but his demand 
is not an effectual demand, as the commodity can never be brought to 
market in order to satisfy it.” (Cannan’s edition, Vol. I, p. 5 8.) 

Any one familiar with modern price analysis can see in the above quota¬ 
tion suggestion of several current concepts. The consumer surplus concept 
appears in the assumption that some persons are willing and able to pay 
more than they have to pay to obtain the object of their desire. The de¬ 
mand-schedule concept appears in the assumption that effectual demand 
would be registered at a lower point if the price for any reason should 
fall. Even the marginal-buyer and marginal-seller concepts might be imag¬ 
ined at the point of equilibrium between buyers and sellers. But only with 
a stretch of the imagination can these concepts be readily attributed to Adam 
Smith. The further and more modern concept of the operation of the law 
of diminishing utility can hardly even be imagined. Much work needed to 


MARKET VALUE 


67 


be done before the authorities on economic. theory furnished a clearly de¬ 
fined theory of market value. 

The superiority of Adam Smith’s work in beginning the discussion 
of the bargaining among a number of buyers on the one side against that 
of a number of sellers on the other side is evident. The demonstration that 
market prices under two-sided competition would adjust themselves at points 
of equilibrium between buyers and sellers at least opened the way for the 
more exact analysis. 

It is somewhat surprising to us now that the later classical economists 
failed to see that the problem required further study. Ricardo accepted Adam 
Smith’s treatment of the subject of market value without question. Although 
he exerted himself nobly in an effort to work out a plausible explanation 
of normal value, we look in vain in Ricardo’s work for a clear distinction 
between market and normal value. The fact is Ricardo seemed unable to 
visualize clearly any other aspect of value than that of normal value. His 
mind seemed automatically to seek out the fundamental and long-time rela¬ 
tionships. His failure to treat distinctly, however, the problem of market 
value is best understood as an outright acceptance of Smith’s treatment of 
that subject. It is well known that Ricardo’s main desire was to supplement 
Smith’s work in places where it appeared to him incomplete. 

Even the antagonists—particularly Sismondi and Owen—whose teachings 
bore directly on value, gave very little attention to market value. In so far 
as they were concerned with market value at all it was to discover some 
method of preventing it from varying from the normal value. Since their 
works show a very superficial comprehension of the subject of normal value, 
naturally their efforts bore little fruit, in the sense of making any addition to 
the knowledge of the subject of value. 

So careful a student as John Stuart Mill failed to see the need of further 
investigation. In his Principles of Political Economy we find the following 
startling statement: "Happily, there is nothing in the laws of value which 
remains for the present or any future writer to clear up; the theory of the 
subject is complete.” (Book III, Chap. 1, Section 1.) 

But in his presentation of the subject as understood in his day, Mill 
did add something to the refinement of the concept of market value. He 
made no substantial advance over Adam Smith’s equilibrium of exchanges. 

The Refinement of the Subject of Market Value. Mill made an 
advance over his predecessors in showing that exchange value should be 
distinguished from price. "The words Value and Price were used as synony¬ 
mous by the early political economists, and are not always discriminated even 
by Ricardo. But the most accurate modern writers, to avoid the wasteful 
expenditure of two good scientific terms on a single idea, have employed 
Price to express the value of a thing in relation to money; the quantity of 


68 


THE EXPANSION OF ECONOMIC CONCEPTS 


money for which it will exchange. By the price of a thing, therefore, we 
shall henceforth understand its value in money; by the value, exchange value 
of a thing, its general power of purchasing; the command which its possession 
gives over purchasable commodities in general.” ( Prin . of Political Economy, 
Book III, Chap. I, Sec. 2.) Thereupon follows an extended discussion showing 
how the value of one thing in terms of another is not always equivalent 
to its value in money. Values in exchange may be rising and falling among 
commodities in relation to one another and at the same time prices as a 
whole may be constant or varying adversely from the change in value or 
any particular commodity. 

"In considering exchange value scientifically, it is expedient to abstract 
from it all causes except those which originate in the very commodity 
under consideration. Those which originate in the commodities with which 
we compare it, affect its value in relation to those commodities; but those 
which originate in itself, affect its value in relation to all commodities. In 
order the more completely to confine our attention to these last, it is con¬ 
venient to assume that all commodities but the one in question remain in¬ 
variable in their relative values. When we are considering the causes which 
raise or lower the value of corn, we suppose that woolens, silks, cutlery, 
sugar, timber, etc., while varying in their power of purchasing corn, remain 
constant in the proportions in which they exchange for one another. On 
this assumption, any one of them may be taken as representative of all the 
rest: since in whatever manner corn varies in value with respect to any one 
commodity, it varies in the same manner and degree with respect to every 
other, and the upward or downward movement of its value estimated in 
some one thing, is all that needs be considered. Its money value, therefore, 
or price, will represent as well as anything else its general exchange value, 
or purchasing power; and from an obvious convenience, will often be em¬ 
ployed by us in that representative character; with the proviso that money 
itself does not vary in its general purchasing power, but that prices of 
all things, other than that which we happen to be considering, remain un¬ 
altered.” (Book III, Chap. I, Sec. 3.) 

Thus, though the problem of market value involves, always, something 
more than mere prices, yet a comprehension of the price phenomena is 
always a primary consideration. A recent illustration of the proposition ad¬ 
vanced by Mill was seen in the behavior of the value of silver during the late 
war. The value of shoes of a certain grade was five silver dollars (in money) 
at the outbreak of the war. But it would have taken ten silver dollars in 
bullion to purchase those shoes. Soon after the" war broke, the value of the 
shoes in terms of money rose to ten dollars. At the same time still ten silver 
dollars in bullion would have purchased the shoes. The market value of the 
shoes had changed in terms of dollars but not in terms of silver. 


MARKET VALUE 


69 


Mill had made an excellent beginning in the analysis of market value 
and prices. It would seem that his appreciation of the importance of the price 
phenomena would have led him on to a more exact analysis of price de¬ 
termination. After which he would have been expected to follow up with a 
correlation of price determination with market value. In his succeeding dis¬ 
cussion we find an extensive amplification of the concept of the equilibrium 
of exchanges, but we look in vain for any great advance over the proposi¬ 
tions worked out by Adam Smith. This advance had to wait the appearance 
of the neo-classical economic philosophy sponsored by Walras, Menger, 
and others. 

Marginalism .—In a crude way the marginal concept existed in economic 
analysis prior to the appearance of the Austrian School of economists. 
Ricardo’s measurement of rent from the no-rent land was really a marginal 
concept. The concept was extended by von Thiinen in his "Isolated State.” 
The fact is that much of the modern economic analysis pays tribute to 
von Thiinen. J. B. Clark specifically gives him credit for suggesting his 
marginal productivity theory of interest. Although the marginal concept 
existed prior to the appearance of the neo-classical treatises, yet the Neo- 
Classicals extended and varied the uses to such an extent as to justify the 
attributing of the coming of marginalism to them. With it the varied 
economic concepts which previously were little more than vague generalities 
became proven hypotheses. 

To Professor Leon Walras belongs the credit for leading off in the ap¬ 
plication of marginalism to market value. Walras, being a leading mathe¬ 
matical economist, was primarily interested in showing the accuracy of the 
assumption of the equilibrium of exchanges. 

The following summary, made by Gide and Rist gives a clear statement 
of the Walras thesis: 

"Let us imagine the whole of society included within one single room, 
say the London Stock Exchange, which is full of tumult of those who 
have come to buy and sell, and who keep shouting their prices. In the center,, 
occupying the place usually taken up by the market, sits the entrepreneur, 
a merchant or manufacturer, or an agriculturist, as the case may be, who 
performs a double function. 

"On the one hand he buys from producers, whether rural or urban, land¬ 
lords, capitalists, or workers, what Walras calls then, 'productive services/ 
that is the fertility of their lands, the productivity of their capital or their 
labor force, and by paying them the price fixed by the laws of exchange 
he determines the revenue of each; to the proprietor he pays rent, to the 
capitalist interest, to the workmen wages. But how is that price determined t 
Just as at the Exchange all values whatsoever are determined by the law 
of supply and demand, so the entrepreneur demands so many services at such 


70 


THE EXPANSION OF ECONOMIC CONCEPTS 


and such a price and the capitalist or workman offers him so many at that 
price, and the price will rise or fall until the quantity offered equals the 
quantity demanded. 

"The entrepreneur on his side disposes of the manufactured goods fash¬ 
ioned in his factory or the agricultural products grown on his farm to those 
very same persons, who merely changed their clothes and became consumers. 
As a mater of fact the proprietors, capitalists, and workers who formerly 
figured as the vendors of services now reappear as buyers of goods. And 
whom else did we expect the buyers to be—who else could they be? 

"And in this market the prices of products are determined in just the 
same fashion as we have outlined above. 

"All at once, however, a newer and grander aspect of the equilibrium 
comes to view. Is it not quite evident that the total value of the productive 
services and the total value of the products on the other side must be mathe¬ 
matically equal? The entrepreneur cannot possibly receive in payment for the 
goods which he has sold to the consumers more than he gave to the same 
persons, who were just now producers, in return for their services. For 
where could they possibly get more money? It is a closed circuit, the quantity 
that comes out through one outlet re-enters through another.” (Gide and 
Rist, pp. 5 83-5 84.) 

This quotation is given in spite of the fact that the marginal concept 
does not appear at the surface. All through it, however, marginalism is 
implied. The fact is marginalism has so many radiations it can better be 
appreciated as we unfold other concepts. 

Definition of a Market .—Fundamental to an exact analysis of market 
value is an accurate definition of a market. From the beginning the econo¬ 
mists’ concept of a market must have been much as it is today. But the early 
economists were not careful to make the concept clear. Modern economists 
are careful to avoid that oversight. Yet definitions of the market are almost 
as numerous as treatises on economics. A simple definition is that given by 
Professor R. T. Ely as any place where the forces operate which determine 
prices. Professor Gide speaks of it as "any area in which the movement of 
goods and communication between buyers and sellers are rapid enough for a 
single price to be established. The extent of the market varies, therefore, 
according to the nature of the goods: any one country constitutes practically 
one market for wheat, and the whole world is one market for gold.” 

Professor Alfred Marshall is careful to say, quoting Cournot: "Economists 
understand by the term market , not any particular market place in which 
goods are bought and sold, but the whole of any region in which the buyers 
and sellers are in such free intercourse with one another that the prices of 
the same goods tend toward equality easily and quickly.” 

The fact is the term market conveys one central idea with many varia- 


MARKET VALUE 


71 


tions. The central idea is the one with which the economist is fundamentally 
concerned, when he is analysing a general fheory of prices. It is necessary 
to find an explanation of the price phenomenon that will apply as well to 
one as another of the variations from the central idea. The central idea is 
that of the balancing of the supply against the demand so as to establish 
the price. The variations may be in any one of several directions. The bal¬ 
ancing of the supply against the demand may appear in the retail market 
or it may appear in the wholesale market. It may be isolated or it may be in 
the thick of society. Some goods have a world market while others have 
only a local market. Likewise there may be a free and open market in which 
the price will be strictly a competitive one; or the market may be a con¬ 
trolled one bringing into play the forces which determine monoply prices. 
Yet regardless of the variations from the central idea in each instance there 
is a balancing of the supply schedule against the demand schedule. Market 
value is, therefore, a composite concept. Special adaptations of the general 
principle of the balancing of the supply schedules against demand schedules 
have to be made in each variation from the central idea. It is in this balancing 
of the demand schedules against the supply schedules that the marginal influ¬ 
ence becomes evident in its relation to market value. 

Supply and Demand Schedules .—Supply schedules mean simply that 
varying amounts of any particular commodity will be offered at varying 
prices—usually the higher the price the more will be offered and the lower 
the less. A definite supply schedule would carry an exact enumeration of the 
varying amounts that would be offered at the varying prices. Likewise de¬ 
mand schdules imply that varying amounts will be taken at varying prices— 
usually the lower the price the more will be taken; the higher the price the 
less will be taken. Definite schedules would carry the exact amounts that 
would be taken at the varying prices. Unfortunately it is impossible to con¬ 
struct these schedules in actual practice. Consequently in making an analysis 
of market prices we have to begin with an assumption which we know to 
be true in principle and construct our exposition on data assumed to be true, 
but known in advance not to be even approximately accurate. If sometime 
in the remote future the science of statistics makes sufficient advance to 
enable economists to secure accurate data for demand and supply schedules 
the science of economics will approximate an exact science. As yet that has 
not been done. The current method of explaining market value therefore 
has to be largely imaginative. Yet the underlying truths are so clearly demon¬ 
strable that the general theses advanced are unanswerable. 

The composite nature of market value becomes immediately apparent 
when we begin to consider the different situations under which market 
value makes its appearance. The first and simplest of these relates to the 
value of a commodity when there is only one seller and one buyer. The 


72 


THE EXPANSION OF ECONOMIC CONCEPTS 


second is when there is one seller and several buyers. The third appears when 
there is one buyer and several sellers. The fourth and last appears when there 
are many sellers and many buyers. 

The pervasiveness of the last mentioned sometimes leads economists to 
neglect analysis of the other three. Each is nevertheless of sufficient signifi¬ 
cance to receive separate treatment. 

If the one-buyer and one-seller relationship involves merely a single 
commodity it is hardly possible to speak of demand and supply schedules at 
all. The question is merely whether or not the particular article will be 
offered at a price which the prospective buyer is willing to pay. The buyer, 
nevertheless, will have a minimum price at which he expects to secure the 
article and a maximum price which he will pay rather than go without it. 
Between these points the buyer will bargain. Similarly the seller will have a 
maximum which he hopes to get and a minimum which he will take rather 
than miss the sale. At some point between the buyer’s maximum and the 
seller’s minimum the price will be determined, unless perchance the buyer’s 
maximum is less than the seller’s minimum. If the two persons are of equal 
bargaining power we should expect the article to exchange at the middle 
point. Any handicap in bargaining power would be expected to operate 
favorably to the other party. If the bargaining relates to more than one 
article buyer’s and seller’s schedules are brought into play. To expect that 
the seller would be willing to part with one of several articles at the same 
price that he would take for each of the whole collection would not be 
sensible. Likewise the buyer would certainly expect to pay a different amount 
for only one of several articles from that which he would expect to pav for 
each of the whole collection. We should have under a circumstance of this 
kind the simplest case of buyer’s and seller’s schedules. 

The problem becomes somewhat more complicated when either or both 
sides of the scales is modified. The next stage appears when there is only 
one seller and a number of buyers. Here the collective and corrective forces 
of the market begin to assert themselves. Here also at least three different 
subordinate situations may prevail. The seller may have only one article 
to sell. That may be the only one in existence and no more like it possible 
of attainment. An example would be an original painting of an old master, 
or possibly an old manuscript. Clearly the law controlling the price of a 
thing like that has its peculiar attributes. The minimum amount that the 
seller could be expected to take would be its cost to him. In the event there 
had been no definite measurable cost, the satisfaction which the owner found 
in the possession of-the article would measure its value to him. It might 
be "priceless’ 5, or it might be "valueless” in his own estimation. In the first 
instance, of course, there would be no sale price. In the second instance there 
might or might not be a sale price. The rest of mankind might feel the same 


MARKET VALUE 


73 


way about the article that the owner did. On the other hand there might be 
a very keen desire on .the part of others for an article that the owner had no 
desire for at all. 

The market value of an article of the kind here contemplated clearly 
may vary between wide points. Very little can be said in advance with 
regard to the price for which a rare manuscript would sell. This fact is 
forcibly brought to our attention by the fabulous sums at which such things 
are sometimes sold. On the contrary at times noble pieces of old furniture 
are purchased from the unappreciative at nominal sums. 

The problem increases in complexity if the seller possesses more than 
one of the rare commodity. An instance would be that of rare postage 
stamps, or rare antiques. The fact that these articles are incapable of repro¬ 
duction would make the schedules one-sided. In this instance, however, the 
supply schedule would become especially pronounced. The seller, or sellers, 
as the case might be would need to find the point at which all of the articles 
would change hands. Clearly that point would be somewhere below what it 
would be if only one article were to be had. The law can easily be stated 
as follows: the price of each article would be that at which the last one 
would be taken. Here we have the influence of the marginal article. Assum¬ 
ing all to be exactly alike, and assuming a demand for them all, and assuming 
the buyers fully aware of one another's offers, the price at which the last 
would be purchased would be the price of each. The more eager purchasers 
might be tricked into paying more. But if they are fully advised of the 
situation they would not need to pay the higher price. The price of the last 
one to go sets the price of each of the others. 

Usually in actual practice the market price of the two situations just 
described is determined at an auction sale. Of these there are two kinds, 
namely, the Dutch auction, and the competitive-bidding auction. In the 
first the pricing is done by the seller; in the second the price is established 
by means of the bidding of the buyers. In the "Dutch” auction the seller 
sets a price at a point as high as he can conceive of any purchaser’s accepting. 
Each day, (or other interval of time) he reduces the price by a predetermined 
amount. Suppose the article to be exposed in a show window and the price to be 
established at $100, to be reduced by one dollar each day until sold. Presum¬ 
ably the article would sell at the maximum amount that the most eager buyer 
is willing to pay. The "Dutch” auction is somewhat slower than the highest- 
bidder plan. The highest-bidder plan of auction is, therefore, most widely 
resorted to. The practice is so well developed in English-speaking countries 
that the professional auctioneer occupies a well defined place in business law. 
The fundamental point, economically speaking, is that goods are offered for 
sale to an assembled crowd of prospective buyers. Many sorts of psychological 
strategy may be resorted to by the auctioneer to stimulate competitive bid- 


74 


THE EXPANSION OF ECONOMIC CONCEPTS 


ding. Presumably the article will change hands at some point above the 
maximum price of the next highest bidder. It might further be presumed 
that in the sale of more than one article the next highest bidder of the first 
sale would be the highest bidder of the second, and so on, until all of the 
available supply has been disposed of. Anyone, however, who has observed 
the behavior of buyers at an auction sale must have experienced difficulty in 
observing that buyers form such a logical alignment in relation to goods 
offered for sale. 

The fact is that only in a very general way is it possible to describe the 
market-value phenomenon in the three situations here considered. Compre¬ 
hension of the economic law to which they tend to conform, however, is 
comparatively simple. 

A further extension of the marginal concept appears in the illustrations 
just given. At the auction sale the next highest bidder establishes the price. 
The price, however, is always one stage above his maximum. He can hardly, 
therefore, be spoken of as the marginal buyer although he is the margina 1 
bidder. 

When there is only one seller and the article offered is freely reproduceab u 
we have a situation which calls for more extended comment. Here we have 
in operation the law of monopoly price. In brief is simply that price wh : ch 
will yield the seller the maximum return above expenses of production. A 
further development of the law of monopoly price is given later (see page 
120 ). 

The counterparts of the situations just described call for comment at 
this point. In this we have the case of one buyer and a number of sellers. 
Actual illustrations here are more difficult to discover. If there is only one 
buyer and a number of sellers, the market value will result from a bearing 
down process instead of a pressing up process evident in the case of one 
seller and a number of buyers, for after all we must admit that the con¬ 
sumer is a more powerful individual than the producer, or to state the 
proposition more accurately the same individual is more powerful as a con¬ 
sumer than he is as a producer. 

The result is that the buyer, if he is skillful, can play off the sellers 
against one another so as to secure the goods at a point very nearly equal to 
the minimum of the most eager seller. The field of operation of the one- 
buyer-several-seller situation is necessarily somewhat more limited than that 
of the one-seller-several-buyer situation. This is true because of the im¬ 
possibility of there being several sellers of a single irreproduceable com¬ 
modity, whereas there may be several buyers of such a commodity. With that 
exception counter relationships exist, for there may be two sellers and one 
buyer of only two commodities, and so on. The economic law controlling the 
price in each of these counter situations is practically the counterpart of 


MARKET VALUE 


75 


those already described. Anyone at all familiar with the behavior of buyers 
and sellers can discover for himself the outcome. 

The above discussions go to show that any effort to comprehend the 
nature of market value is futile unless it is preceded by a number of pre¬ 
liminary considerations. The peculiar situation under which the laws de¬ 
termining the price are operating has a powerful influence on the behavior of 
those laws. The situations, moreover, shade into one another in such a way 
that it is almost impossible to find one operating entirely independently 
of the other. Even when it would appear—as, for instance, in the sale of a 
single painting of a great master long since dead—that no possible ulterior 
force could neutralize the influence of the pure economic law, the possibility 
of substitution might prevent the price from going as high as it might 
otherwise go. Where pure competition is not operative, substitution is. Hence 
any categorical statement of the operation of the laws determining market 
value must always be received cautiously. 

The greatest field of market value remains to be analysed. It relates to 
the two-sided competition—where there are many buyers and many sellers. 
In presenting the concepts here described the author is not presuming to 
add anything to the works of present-day authorities but rather to pick from 
them the essentials of their discussions of the subject. It is in this connection 
that the major aspects of the market-value phenomenon appear in clear 
perspective. 

Supply and demand schedules are presented by Professor Seager as follows: 
"The last and most common situation is that in which there are several buyers 
and several sellers, among whom more or less active competition and active 
bargaining are carried on. This is well illustrated in a modern produce market 
and in discussing it we may revert to the demand and supply scales for 
wheat . . . The demand scale indicates the quantities that buyers are willing 
to take at different prices. The supply scale, the quantities which, at the 
same prices, sellers are willing to part with. Fear that they may fail to get 
the supplies they desire will lead buyers to bid against one another; anxiety 
to realize the highest possible prices will deter sellers from disposing of their 
supplies until they are convinced that the maximum price for the time 
being has been reached. At $0.95, as the scales show, 4,000,000 bushels may 
be bought, but buyers stand ready to take 7,500,000 bushels. This price is 
evidently too low. At $0.96, 4,500,000 bushels are available, but buyers 
stand ready to take 7,000,000. The price is still too low. Competitive bidding 
will advance the price to $0.97. At that figure 5,000,000 bushels would be 
bought, but buyers want 6,000,000 bushels. Sellers, by holding back, can 
get a still higher price. Will the price go to $0.98? No, because at that 
figure buyers will take only 5,000,000, whereas 6,000,000 bushels are ready 
for sale. Free competition guided by full knowledge and equal skill in bar- 


76 


THE EXPANSION OF ECONOMIC CONCEPTS 


gaining on the side of both buyers and selers would fix the price somewhere 
between $0.97 and $0.98. At this price between 5,000,000 and 6,000,000 
bushels would exchange hands, and only those buyers who were unwilling to 
pay as much and those sellers who were unwilling to accept as little as this 
would go away disappointed. Of course, in practice, full knowledge and equal 
bargaining power are rarely if ever present in a competitive market; so all 
that we can say with confidence is that free competition in the purchase 
and sale of a commodity among a number of buyers and sellers tends to bring 
about the result that we have described, that is, a price at which the maxi¬ 
mum number of sales can be effected.” (Principles of Economics , pp. 115- 
116 .) 

"In some markets prices are determined in exactly the way that has 
been described. On some stock exchanges, for example, brokers are required 
to communicate their bids and offers in writing to an officer of the exchange. 
At the close of the market these bids and offers for each stock are examined 
and the price fixed which will effect the largest number of transactions. 
This one price, irrespective of the fact that their own bids or offers may 
have been much higher or much lower, is paid all brokers who bid that 
amount or more and is received by all sellers who offered stock at that 
amount or less. In most markets other methods for fixing prices are used, 
but nevertheless, the illustration given indicates in a fair degree of accuracy 
the forces at work and the goal toward which they are directed in any 
competitive market.” (Ibid. p. 117.) 

A number of supplementary concepts have now to be brought into play 
before we can secure a well balanced view of market value. It should be 
clear at this point that there is really no such a thing as fixity of supply or 
demand. Demand simply means the amount that will be purchased at a given 
price, and supply the amount that will be offered at a given price. Supply 

FIGURE 1. 

Graphical representation of the balancing of 
the supply and demand schedules in the de¬ 
termination of market value. 

The vertical line denotes price and the hori¬ 
zontal line quantity. When the price is low 
the supply offered on the market is small. When 
the price is high the supply offered is great. 
Exchange must of necessity take place just where 
the demand and supply are equal, which is 
marked by the point of intersection of the two 
lines. The amount demanded is equal to the 
amount offered. 

supply are assumed to vary in exact regularity. 
A single point variation in price is matched by a regular and equal variation in the quantity 
offered on the market. Such an assumption as this is certainly far from that which can 
actually be expected to happen in many instances. Further, it can hardly be expected that 
the supply and demand curves will be similar for any two different commodities. 





MARKET VALUE 


77 


is best thought of as a stream of goods or services, and demand as a stream 
of purchasers. 

It is the practice now to bring into play curves and graphs to illustrate 
the idea to be conveyed. These are purely imaginary in construction and can 
in fact be as readily described as plotted. For the benefit of those who may 
not have access to the authorities, some of the most suggestive of these curves 
are given. Ready reference can be made to the authorities for other figures 
there presented. 

Elasticity of Demand .—It would seem from the above description of 
supply and demand schedules that the balancing of the supply scales against 
the demand scales would be a regular and consistent process. The fact is 
that the supply and demand schedules vary widely with commodities. This 
fact gives rise to the phenomenon of elasticity of demand. 

To understand elasticity of demand three concepts are best first con¬ 
sidered. They are unity of demand, absolute rigidity of demand, and perfect 
flexibility of demand. 

Professor Alfred Marshall has the following to say regarding the first 
of these: "We may say that elasticity of demand is one, if a small fall in 
price will cause an equal proportionate increase in the amount demanded: 
or as we may say roughly, if a fall of one per cent in price will increase the 
sales by one per cent; that it is two or a half, if a fall of one per cent in 
price makes an increase of two or one-half per cent respectively in the 
amount demanded; and so on. (This statement is rough; because 98 does 
not bear exactly the same proportion to 100 as does 102.) The elasticity of 

COMMENT ON FIGURE 2—UNITY OF DEMAND 

"Let a straight line touching the curve at any point P meet Ox in T and Oy in t, then 
the measure of the elasticity at the point P is the ratio of PT to Pt. 

"If Pt were twice Pt, a fall of 1 per cent, in 
price would cause an increase of 2 per cent., 
in the amount demanded; the elasticity of de¬ 
mand would be two. If PT were one-third of Pt, 
a fall of 1 per cent, in price would cause an 
increase of 1 / 3 per cent, in the amount de¬ 
manded; the elasticity of demand would be one- 
third; and so on. Another way of looking at 
the same result is this:—the elasticity at the point 
P is measured by the ratio of PT to Pt, that is 
of MT to MO (PM being drawn perpendicular 
to Om); and therefore the elasticity is equal to 
one when the angle TPM is equal to the angle 
OPM; and it always increases when the angle 
TPM increases relatively to the angle OPM, and 
vice versa” —Marshall’s Principles of Economics, 
p. 103 foot note. 

FIGURE 2—UNITY OF DEMAND 
(A reproduction from Marshall’s Principles of Economics, p. 102). 

Courtesy of the Macmillan Company 






78 


THE EXPANSION OF ECONOMIC CONCEPTS 


demand can best be traced in the demand curve.” (Principles of Economics, 
p. 102, note.) 

We see from the above that elasticity of demand is best thought of as 
variations from unity. The two other concepts are perfect rigidity of de¬ 
mand and perfect elasticity. When demand is perfectly rigid there is no 
variation in amount purchased with a variation in price. The first—perfect 
inelasticity—would mean no curve at all, whereas the second—unity of 
demand—would be a graph in the form of an isosoceles triangle. Perfect elas¬ 
ticity would be represented by a straight line parallel to the base. It is safe to 
say that no commodity can be found that would exactly conform to any of 
these concepts. The concepts are merely of scientific significance. 

Elasticity of demand, therefore, means that the amount purchased varies 
with the price. It has sometimes been said that particular commodities have 
an elastic or inelastic demand. Careful analysis shows, however, that hardly 
any commodity can be spoken of as possessing exclusively an elastic or an 
inelastic demand. Generally speaking necessities of life are more inelastic than 
are luxuries. About all that can be said with absolute certainly is that at 
certain stages goods have elastic demand, and at other stages on the price 
scale the demand becomes inelastic. Furthermore goods vary among themselves 
with regard to where the elasticity or inelasticity will appear. Professor 
Marshall has shown that it is possible for a commodity to vary from almost 
perfect rigidity to almost perfect elasticity. He takes as his illustration green 
peas: 

"Let us illustrate by the case of the demand for green peas in a town 
in which all vegetables are bought and sold in one market. Early in the 
season perhaps 100 lbs. a day will be brought to market and sold at Is per 
lb., later on 500 lbs. will be brought and sold at 6d, later on 1000 lbs. at 
4d, later still 5000 at 2d, and later still 10000 at l^d.” {Ibid. p. 104, 
note.) 

Professor Marshall finds the explanation in the fact that demand goes 
with classes of purchasers. He proceeds to tabulate as follows: 


At price in Number of pounds bought by 


pence per lb. 

Rich 

Middle Class 

Poor 

Total 

12 

100 

0 

0 

100 

6 

300 

200 

0 

500 

4 

500 

400 

^ 100 

1000 

2 

800 

2500 

1700 

5000 

1/2 

1000 

4000 

5000 

10000 


Reducing these figures to curves, the first stage shows an almost vertical 
drop, the second a less rapid drop, and the third almost an horizontal line (see 
Fig. 3). 


MARKET VALUE 


79 


• A curve of the kind could probably 
be constructed for almost any com¬ 
modity, although, of course, the price 
alignment would of necesity be dif¬ 
ferent. The early market for peas is 
highly elastic. A 6 d reduction in price 
increased the amount taken a compara¬ 
tively small extent. Another 2d drop 
caused a slightly larger total increase 
in amount taken. Only when the price 
fell to the point where the poor people 
could afford to buy green peas did the 
demand show a phenomenal response to 
the fall in price. By way of further 
comment it should be added that it is 
doubtful whether a further reduction 
in price would have had much influence 
on the amount taken. At the low point 
demand would become rigid again. This 
fact explains the well known fact that 
commodities under certain circumstances become drugs on the market. 

Such commodities as cotton and wheat are said to have the habit of a 
wide variation in their market prices because of the fact that they have very 
inelastic demands. That is true, of course, within the ordinary range of the 
prices of those commodities. Who can say what would happen to the de¬ 
mand for cotton if through some magic of productive efficiency it could be 
produced and sold profitably at a half cent a pound? Or to the demand for 
wheat if it could be sold at ten cents a bushel? 

Irregularities of the Demand and Supply Schedules .— (1) Indirect (de¬ 
rived), joint, composite, and rival demands. Demand schedules vary among 
themselves. Demand is said to be indirect or derived when the demand is 
for something with which to satisfy a more definite demand. The demand 
for a reel and rod with which to go fishing is an instance. There would be 
no desire for the fishing tackle except for the desire to fish. The demand for 
raw material and other means of production is said to be indirect. 

Joint demand relates to the supplementary uses of commodities. For 
example the gun is of slight value without the cartridge, or the cartridge 
without the gun; the wagon without the horse^ or the horse without the 
wagon, etc. Joint demand becomes composite when it is compounded of 
different groups of people who may desire the commodity. Composite de¬ 
mand may be itself supplementary or rival dependent upon the relation of 



FIGURE 3—ELASTICITY OF DEMAND 

(Reproduced from Marshall’s Principles 
of Economics, p. 104). 

Courtesy of the Macmillan Company 













80 


THE EXPANSION OF ECONOMIC CONCEPTS 


the groups to each other. It takes comparatively little experience in business 
to find illustrations of each of these. 

(2) Indirect (derived), joint, composite, and rival supply. Supply 
schedules also vary among themselves similarly to the demand schedules. The 
great volume of goods known as by-products belong to the category of in¬ 
direct or derived supply. The wheat-straw along with the wheat, the cotton¬ 
seed along with the cotton, fertilizers and soap in slaughter houses, etc., all 
belong to the group of commodities known as derived products. The market 
phenomena of some of these commodities have in a number of instances been 
very interesting. Illustrations are found in the case of cotton-seed in the 
South, and wheat-straw in England. 

The distinction between indirect, or derived, supply and joint supply 
needs to be carefully drawn. An illustration of a joint product is found in 
the relation of lamb to mutton, or veal to beef. A nice little problem 
is found in connection with whether or not it is more profitable to market 
the lamb, or to let the animal grow up. In no sense can the lamb be said to 
be an indirect product of the sheep. They are joint products. Many similar 
illustrations can be found of joint supplies, all of which go to complicate 
the problem of market value. 

An extension of this same idea brings into play the phenomenon of com¬ 
posite and rival supplies. Beef and mutton, for instance, in some ways are 
composite, and in others are rival supplies. They are certainly composite when 
the well balanced hotel menu is being prepared; as is true of many other 
commodities; they are rival supplies when the selection of the one means 
the exclusion of the other. 

Thus we see that when first contemplated the demand and supply 
schedules appear comparatively simple. When they are submitted to careful 
analysis they reveal difficulties. Without these supplementary concepts any¬ 
thing like an accurate comprehension of supply and demand schedules is 
quite impossible. 

The Marginal Buyer and the Marginal Seller .—The sensitive spot in the 
theory of market value is called the marginal buyer and the marginal seller. 
Although one of the least concrete of all economic concepts, it is here that 
the modern theory of market value appears more scientific than that of the 
Classicals. 

It is evident that the different buyers and sellers play a different part 
in the final act of establishing the market price. The fact is that the actual 
market price conforms to the amount that only one buyer is willing to pay. 
Similarly it conforms exactly to the amount that only one seller is willing 
to offer. These amounts are one and the same. Other buyers and sellers have 
to conform or remain without. All of those who were willing to pay more 
rather than do without, finding that the market value, or price, is less than 


MARKET VALUE 


81 


the amount they would pay if they had to, now refuse to pay the extra 
amount for the very simple reason that they do not have to. They are spoken 
of as having a buyers’ of consumers’ surplus—the difference between the 
amount they would pay and the amount that they have to pay. The buyer 
who is just willing to pay the price, therefore, is the marginal buyer. He 
has no surplus. A like analysis relates to the sellers. Those sellers who were 
willing to sell for less, finding that they do not have to do so, of course, 
bring their prices in line with the higher price. Those who are unwilling to 
accept the market price simply withdraw. The sellers who secure more 
than they would have accepted have a surplus—known as producers’ or 
sellers’ surplus. The one seller to whom the price afforded by the equilibrium 
established by the balancing of the supply scales against the demand scales 
conforms exactly to the amount which he expected to secure is called the 
marginal seller. He has no producer’s surplus. He is the seller whose goods 
are needed along with those who are willing to sell more cheaply to satisfy 
the equation. They are sometimes spoken of as the limiting couple. Clearly 
the amount for each has to be one and the same thing—the market price. 

COMMENT OF FIGURE 4—CONSUMER’S SURPLUS 

Before giving the explanation of the diagram of Consumer’s Surplus, we should present 
Professor Marshall’s defence against the attack on the assumption of its existence. It proceeds 
as follows: 

"Professor Nicholson ( Principles of Political Economy, Volume 1, and Economic Journal, 
Volume IV.) has raised objections to the notion of consumers’ surplus, which has been answered 
by Professor Edgeworth in the same Journal. Professor Nicholson says: 'Of what avail is it 
to say that the utility of an income of (say) £l00 a year is worth (say) £1000 a year?’ There 
would be no avail in saying that. But there might be use, when comparing life in Central 
Africa with life in England, in saying that, though the things which money will buy in 
Central Africa may on the average be as cheap there as here, yet there are so many things 
which cannot be bought there at all, that a person with three or four thousand a year there 
is not as well off as a person with three or four hundred a year here. If a man pays Id. toll 
on a bridge, which saves him an additional drive that would cost him a shilling, we do not 
say that the penny is worth a shilling, but that the penny, together with the advantage 
offered him by the bridge (the part it plays in his conjuncture) is worth a shilling for that 
day. Were the bridge swept away on a day which he needed it, he would be in at least as bad 
a position as if he had been deprived of eleven pence. ( Principles of Economics, p. 127, 
footnote). 

By way of explaining the graph descriptive of consumers’ surplus Professor Marshall 
proceeds: "Let us consider the demand curve DD for tea in any large market. 

"Let OH be the amount which is sold there at the price HA annually, a year being 
taken as our unit of time. Taking any point M in OH, let us draw MP vertically upwards 
to meet the curve in P and cut a horizontal line through A in R. We will suppose the 
several lbs. numbered in the order of the eagerness of the several purchasers: the eagerness of 
the purchaser of any lb. being measured by the price he is just willing to pay for that lb. The 
figure informs us that OM can be sold at the price PM; but that any higher price not quite 
so many lbs. can be sold. There must be then some individual who will buy more at the price 
PM, than he will at any higher price; and we are to regard the OMth lb. as sold to this indi¬ 
vidual. Suppose for instance that PM represents 4s., and that OM represents a million lbs. The 
purchaser described in the text is just willing to buy his fifth lb. of tea at the price 4s., and the 
OMth or millionth lb. may be said to be sold to him. If AH and therefore RM represents 2s., 
the consumers’ surplus derived from the OMth lb. is the excess of PM, or 4s. which the pur- 
chaser of that lb. would have been willing to pay for it over RM, the 2s. which he actually 
does pay for it. Let us suppose that a very thin vertical parallelogram is drawn of which the 


82 


THE EXPANSION OF ECONOMIC CONCEPTS 


height is PM and of which the base is the distance along Ox that measures the single unit or 
lb. of tea. It will be convenient henceforward to regard price as measured not by a mathematical 
straight line without thickness, as PM; but by a very thin parallelogram, or as it might be 
called, a thick straight line, of which the breadth is in every case equal to the distance along 
Ox which measures a unit or lb. of tea. Thus we should say that the total satisfaction derived 
from the OMth lb. of tea is represented (or, on the assumption made in the last paragraph of 
the text is measured) by the thick straight line MP; that the price paid for this lb. is represented 
by the thick straight line MR and the consumers’ surplus derived from this lb. by the thick 
straight line RP. Now let us suppose that such thin parallelograms, or thick straight lines, 
are drawn from all positions of M between O and H, one for each lb. of tea. The thick straight 
lines thus drawn, as MP is, from Ox up to the demand curve will each represent the aggregate 
of satisfaction derived from a lb. of tea; and taken together thus occupy and exactly fill up 
the whole area DOHA. Therefore we may say that the area DOHA represents the aggregate 
of the satisfaction derived from the consumption of tea. Again, each of the straight lines 
drawn, as MR is, from Ox upwards as far as AC represents the price that actually is paid for 
a lb. of tea. These straight lines together make up the area COHA; and therefore this area 

represents the total price paid for tea. Finally 
each of the straight lines drawn as RP is from 
AC upwards as far as the demand curve, repre¬ 
sents the consumers’ surplus derived from the 
corresponding lb. of tea. These straight lines 
together make up the area DCA; and therefore 
this area represents the total consumers’ surplus 
that is derived from tea when the price is AH. 
But it must be repeated that this geometrical 
measurement is only an aggregate of the meas¬ 
ures of the benefits which are not all measured 
on the same scale except on the assumption just 
made in the text. Unless that assumption is 
made the area only represents an aggregate of 
satisfaction, the several amounts of which are 
not exactly measured. On that asumption only, 
its area measures the volume of the total net 
satisfaction derived from tea by its various pur- 
M H x chasers.” (Ibid. 12 8, footnote). 

FIGURE 4—CONSUMERS’ SURPLUS 
(Reproduced from Marshall’s Principles of Economics, p. 12 8) 

Courtesy of the Macmillan Company 



COMMENT ON FIGURE 5—PRODUCERS’ SURPLUS 

The practical significance of the concept of producers’ surplus is much more complicated 
than that of consumers surplus, resting as it does on cost of production. Not very much 
can be done with it until we have comprehended the phenomenon of rent and its several 
ramifications. Yet we feel that a consideration of Professor Marshall’s diagram is pertinent at 
this point. 

"In the adjoining diagram, SS’ is not a true supply curve adapted to the conditions of 
the world in which we live; but it has properties, which are often erroneously attributed to 
such a curve. We will call it the particular expenses curve. As usual, the amount of a com¬ 
modity is measured along Ox, and its price along Oy. OH is the amount of the commodity 
produced annually, AH is the equilibrium price of a unit of it. The producer of the OHth 
unit is supposed to have no differential advantages; but the producer of the OMth unit has 
differential advantages which enable him to produce with an outlay PM, a unit which it 
would have cost him an outlay, AH, to produce without those advantages. The locus point 
P is our particular expenses curve; and it is such that any point P being taken on it, and PM 
being drawn perpendicular to Ox, PM represents the particular expenses of production in¬ 
curred for the production of the OMth unit. The excess of AH over PM = QP, and is a 
producer’s surplus or rent. For convenience the owners of differential advantages may be 
arranged in descending order from left to right; and thus SS’ becomes a curve sloping upward 
to the right.” (Ibid. 811). 







MARKET VALUE 


83 



FIGURE 5—PRODUCERS’ SURPLUS 
(Reproduced from Marshall’s Principles of Economics, p. 811). 

Courtesy of the Macmillan Company 


At first they are likely to be considered as determining the value; but they 
are better thought of as indicating the value. The following quotation from 
Professor Alfred Marshall is worthy of careful consideration: 

"The part played by the net product at the margin of production in the 
modern doctrine of Distribution is apt to be misunderstood. In particular 
many able writers have supposed that it represents the marginal use of a 
thing as governing the value of the whole. It is not so; the doctrine says 
we must go to the margin to study the action of those forces which govern 
the value of the whole: and that is a very different affair. Of course the 
withdrawal of (say) iron from any of its necessary uses would have just 
the same influence on its value as its withdrawal from its marginal uses; 
in the same way as pressure in a boiler for cooking under high pressure would 
be affected by the escape of any other steam just as it would by the steam 
in one of the safety valves: but in fact the steam does not escape except 
through the safety valves. In like manner iron, or any other agent of pro¬ 
duction, is not (under ordinary circumstances) thrown out of use except 
at points at which it yields no clear surplus of profit; that is, it is thrown 
out from its marginal use only.” ( Principles of Economics, p. 410.) 

This concept of the marginal influence as indicating rather than gov¬ 
erning the value is of vital importance for a clear understanding of the 
problem. As already noted, the prime difficulty is to discover the indicator. 







84 


THE EXPANSION OF ECONOMIC CONCEPTS 


The fact is that the price indicates the marginal influence rather than is 
indicated by it. Yet our good sense tells us that the marginal influence 
operated in the way described, and thus registers market value. 

The Fair Price .—There must be an explanation of the fact that under 
some circumstances a person may feel that he has been cheated, whereas 
under other circumstances, even though the goods may be'secured at a price 
no cheaper the same person may not feel that he has been dealt with un¬ 
fairly. A consideration of the points brought out in this chapter will give the 
answer to that question so far as the market value is concerned. If there has 
been no interference with the full sweep of the laws of supply and demand 
the buyer accepts the consequences without serious complaint. It is only 
when there has not been a full sweep of these laws that one feels that one 
has been dealt with unfairly. The fair price is therefore the current market 
price. When a seller is able to secure more than that he feels that he has 
been an extra-good bargainer, and when the buyer pays more than that he 
feels that he has been duped. 

But the question may be asked, is it not possible for the market value 
to be too high? An answer to that question takes us into the consideration 
of problems relating to normal value. These are studied in the next chapter. 



Alfred Marshall (1842-1924) 


"Marshall came of a good middle-class family, of modest means and pious habits, his 
father being employed as a cashier at the Bank of England. The boy’s early evidence of high 
mental faculties secured him a place in the Merchant Taylors School in London, where his 
education was largely in the classics. His interest, however, turned gradually in the direction 
of mathematics, so that upon completion of his secondary schooling he refused a classical 
scholarship at Oxford and turned to Camridge and mathematics. Graduating in 1865 with 
high honors, he became a lecturer in mathematics, with the intention of pursuing his further 
studies in the field of physics. During his school and university period his intention had 
been eventually to take holy orders in the Anglican Church. Of devout evangelical parent¬ 
age, his own religious feeling was strong and his mind intermittently turned to the thought 
of foreign missionary work as his proper field. From an early age, therefore, his mind was 


85 




86 


THE EXPANSION OF ECONOMIC CONCEPTS 


divided between religious and humanitarian zeal and a strong bent for abstract intellectual 
pursuits. 

“Marshall’s associations at Cambridge after his graduation threw him into the society 
of a group of men interested in philosophical studies, a group which included T. H. Green, 
F. D. Maurice, W. K. Clifford, and Henry Sidgwick. Pursuing for the time this new philo¬ 
sophical interest, he became engrossed in Kant and a little later fell much under the influence 
of Hegel’s philosophy of history. His mental confusion was much increased by contact with 
Darwin’s Origin of Species and the works of utilitarian philosophers. A mental crisis followed 
the impingement of these new ideas upon established religious convictions. His interest in 
mathematical and physical science gave way to 'a sudden rise of deep interest in the philo¬ 
sophical foundation of knowledge, especially in relation to theology,’ as he has himself re¬ 
corded. Out of the confusion of this period there developed in Marshall’s mind the attitude 
of intellectual agnosticism combined with a sort of religious humanitarianism so character¬ 
istic of the better minds of that disturbed generation. 

“Intellectually unsatisfied by the metaphysical and scientific studies that had under¬ 
mined his theological preconceptions, he directed his attention to the field of social ethics. 
Much disturbed over the ethical justification of existing forms of social institutions, he 
came under the influence of Mill’s economic writing, and of Bentham and Spencer. In the 
study of how the material lot of the common man might be lifted above the poverty and 
depravity which he saw about him, he found an outlet for his religious zeal, and his interest 
and attention swung sharply in that direction. It is possible to see, then, what manner of 
young man it was who ceased his mathematical lectures in 18 68 and took up a new lecture¬ 
ship in the Moral Sciences, where his weight listed the ship sharply to the side of political 
economy. A brilliant mathematician, a young philosopher carrying a somewhat undigested 
load of German metaphysics, Utilitarianism, and Darwinism; a humanitarian with religious 
feelings but no creed, eager to lighten the burdens of mankind, but sobered by the barriers 
revealed to him by the Ricardian political economy—one sees the background of the man who 
was to be his students’ sage and pastor as well as scientist; whose objective scientific approach 
was to give economics a renewed public standing; whose sympathy for social reform was to 
rout its enemies; whose high gifts were to be zealously devoted to his intellectual mistress as 
any artist’s to his muse. 

“Except for eight years, from 1877 to 1 8 8 5, when he taught at Bristol and Oxford, 
Marshall’s life was spent entirely at Cambridge. He held the professorship of political economy 
from 1885 until his retirement in 1908, and, until his death in 1924, continued his inde¬ 
pendent work in his old surroundings. One result of his work at Cambridge was to make it 
so far the superior center of economic training in England that, until the rise of the London 
School of Economics, it attracted for a generation a large proportion of the best brains of the 
country that contemplated economic studies. 

“Marshall’s books, unfortunately, do not round out in any systematic fashion the whole 
of his views. His work has been marred from first to last by his inability to work to a pre¬ 
conceived plan and by his unwillingness to publish anything until it was as perfect as he 
could make it. The broad survey of economic life of which the Principles was conceived to 
be the introductory volume was never completed. The other volumes came near the end of 
his life and are composed of materials which he had been collecting for a lifetime. Expanding 
as they did under his hands, much was crowded out for which he would have wished a place, 
and he was left at his death with the material for three further studies he had intended on 
conditions affecting employment, the economic functions of government and the economic 
conditions of progress. It remains true, however, that in the eyes of many the Principles is 
the greatest text on economic theory that has been written.”—Paul T. Homan: Contemporary 
Economic Thought, pp. 196-200. 

To hold that Professor Marshall’s treatise on economics is a well-rounded 
treatment of the subject is far from the truth. To state that he has taken 
the science at its most difficult points and pushed the theory further than any 
other authority is a great enough tribute to any intellect. Marshall’s great 
work relates to his extension of the theory o-f rent and the amplification of 
the theory of normal value. Without his passages on those subjects the science 
of economics would be less complete than it is. With those extensions a 
comprehension of the science requires the most intense study. 


CHAPTER V. 


NORMAL VALUE 

As noted at the close of the preceding chapter producers and con¬ 
sumers are both much concerned about a fair price. The producers are 
concerned about securing a fair price for that which they have to sell. Con¬ 
sumers are often wrought up about the price of things which they have to 
buy. Both are usually very sure that they know what is a fair price. If either 
or both are asked to state what they considered a fair price, the answer 
would almost without question be that of cost of production plus something. 
The producer feels that he is entitled to a price equal to his cost of pro¬ 
duction plus something for his own effort. The buyer, much more vaguely, 
seems to feel the same way about it. He feels, however, that it is the pro¬ 
ducer’s lookout that he get at least as much as the goods cost him. It is only 
when the price, in the mind of the buyer, exceeds the cost of production that 
he actually asserts himself against the prevailing market price. Whenever the 
buyers or the sellers have actively asserted themselves, it has been revealed 
to them that invisible forces are at work in the determination of the value 
of things that are beyond the comprehension of mere observers. The problem 
of stating and explaining the invisible forces has taxed the ingenuity of 
some of the most profound students of the modern era. It is this field of 
inquiry that concerns us now. 

The Physiocrats and the Normal-Value Concept. The fact that 
the Physiocrats made no definite allusion to the theory of value has led 
some authorities—notably Gide and Bust—to conclude that they had no 
theory of value. We have already seen that they did have a superficial 
theory of market value in their bon prix concept. Their theory of normal 
value is even more remote than their market-value concept. 

The Physiocratic normal-value thesis, however, has to be deducted from 
their net-product thesis. 

We have already noted that they thought of agriculture alone as being 
productive. The net product was a sort of surplus that went to the landed 
proprietors. Unless the proprietors were careful not to take more than the 
net product the farmers would suffer. There was, therefore, a sort of "means 

87 



88 


THE EXPANSION OF ECONOMIC CONCEPTS 


of subsistence” theory of normal value. A similar thesis was advanced with 
regard to the artisans, for according to the tableau economique , the artisans 
had to retain their milliard in order to live. 

Support of this contention that the Physiocrats had a theory of normal 
value is found in the following quotation: "They thought that wages and 
profits being thus fixed by natural laws, the natural value of everything was 
governed simply as the sum of wages and profits required to remunerate the 
producers.” (Alfred Marshall’s Principles of Economics , p. 506.) 

Adam Smith and the Normal-Value Concept. With the exception 
that Adam Smith recognized the existence of a norm above and below 
which the market value fluctuated, he added very little to the theory of 
normal value. He spoke of it as the "natural” value, or price. When he gave 
any attention at all to the explanation of this "natural value,” apparently he 
was baffled by it. At one place in his treatise he alludes to the cost of pro¬ 
duction—wages, profits, and rent—as determining the natural value. In 
another it was the amount of labor expended. He never chose between the 
two. Thus Adam Smith left the theory of normal value without any sub¬ 
stantial contribution to it, except that of calling attention to the fact that 
market value and normal value demand separate treatment. 

Ricardo and the Labor Theory of Value. The next authority who 
would be expected to help to clarify the subject was J. B. Say. Although 
Say thought very clearly about certain aspects of price phenomena, yet 
we look in vain in Say’s treatise for any significant advance over Adam 
Smith’s treatment of the relation between market price and natural price. 
We shall return to Say’s treatment of the subject when we consider the 
matter of prices separately. 

Ricardo, however, studied deeply the problem of normal value. In con¬ 
trast with his great predecessor, Ricardo gave very little attention to market 
value. The deeper aspects of value were his main interest. Ricardo’s mind 
seemed to look for the fundamental. With regard to value it does that 
without even clearly calling attention to the fact that it is normal value 
instead of market value that he is trying to understand. The following quota¬ 
tion gives in a summary way Ricardo’s theory of value: 

"Value, then, essentially differs from riches, for value depends not on 
abundance, but on the difficulty or facility of production. The labour of 
a million men in manufactures will always produce the same value, but 
will not always produce the same riches. By the invention of machinery, by 
improvements in skill, by a better division of labour, or by the discovery 
of new markets, where more advantageous exchanges may be made a million 
men may produce double or treble the amount of riches, of 'necessaries, con¬ 
veniences, and amusements,’ in one state of society that they could produce 


NORMAL VALUE 


8 9 


in another, but they will not on that account add anything to value; 
for everything rises or falls in value in proportion to the facility or difficulty 
of producing it, or in other words, in proportion to the quantity of labour 
employed on its production. Suppose, with a given capital, the labour of 
a certain number of men produced 1000 pairs of stockings, and that by 
inventions in machinery the same number of men can produce 2000 pair, or 
that they can continue to produce 1000 pair, and can produce besides 500 
hats; then the value of the 2000 pair of stockings, or of the 1000 pair of 
stockings and 500 hats will neither be more nor less than that of 1000 pair 
of stockings before the introduction of machinery; for they will be the pro¬ 
duce of the same quantity of labour. But the value of the general mass of 
commodities will nevertheless be diminished; for, although the value of the 
increased quantity produced in consequence of this improvement will be the 
same exactly as the value would have been of the less quantity that would 
have been produced had no improvement taken place. An effect is also 
produced on the proportion of goods still unconsumed, which were manu¬ 
factured previously to the improvement; the value of those goods will be 
reduced, inasmuch as they must fall to the level, quantity for quantity, of 
the goods produced under all the advantages of the improvement; and society 
will, notwithstanding the increase quantity of commodities, notwithstanding 
its augmented riches, and its augmented means of enjoyment have a less 
amount of value.” (Ricardo, Principles of Political Economy , Chapter XX.) 

Language like that goes to show how desperately unsatisfactory was the 
theory of value in Ricardo’s day. When we recall that Ricardo was the 
preeminent authority on economic theory at that time we are all the more 
bewildered. 

In the language quoted, however, we can see the dawning of several 
concepts that do service later. The distinction between value and riches 
is nothing more than the distinction (alluded to several times in this study) 
between value and wealth. The further statement that lessening the amount 
of work required in a given productive process would reduce all values 
is accounted for by the fact that utility had not at that time been dis¬ 
tinguished from value. The effect would be registered on utilities, and possibly 
values in use, but it is not so evident that the effect would be registered as 
against values in exchange. It should always be remembered that values in 
exchange are ratios. It is only by a different modification of the numerator 
from that of the denominator or of the denominator from that of the 
numerator that ratios are changed. Of course, if all commodities were in¬ 
creased up to the point of satiety all values would disappear. That is a 
consummation impossible of attainment. But even at that no alterations 
need be made in the statement that exchange values are ratios, for if all com- 


90 


THE EXPANSION OF ECONOMIC CONCEPTS 


modities were increased to the point of satiety exchanges would stop, but the 
ratios would remain constant. 

This brings us face to face with the problem over which Ricardo was 
puzzling. Why is it that some goods are normally worth more than other 
goods? The market value of sugar, say, may oscillate above and below six 
cents a pound (retail), whereas in the same market the value of salt may 
oscillate around one cent a pound. Why does that happen? Ricardo said 
because it takes six times as much labour to produce sugar as it takes to pro¬ 
duce salt. Hence the difference, and so on for other commodities. Goods, 
according to the Ricardian concept, form themselves into a value structure 
based on the amount of labour it takes to produce them. Any variation of 
the market value from this structure tends to correct itself automatically, 
because if one commodity becomes relatively more easily produced than 
another, labor will shift into the production of that commodity until the 
slack is taken up. 

Adam Smith had already sensed the fact that all labor is not equally 
efficient. He had suggested primitive labor as the basic labor measure. Ricardo 
also sensed the fact that labor is not equally efficient and suggested maximum 
amount of labor as the basis of calculation. The fact that labor itself is 
valuable, and that the value of labor itself is as much an objective of the 
economic theory of value as commodities themselves seemed never to have 
crowded itself into Ricardo’s consciousness. 

Ricardo, however, realized that he had not worked out a satisfactory solu¬ 
tion to the problem of value. After having worked for years on the subject 
he finally admitted to McCulloch, in a letter of December 18, 1819: "I am 
not satisfied with the explanation which I have given of the principles which 
regulate value. I wish a more able pen would undertake it.” And in a letter 
to Malthus written on August 15, 1820, speaking of his own theory of 
value and of McCulloch’s he despairingly adds: "Both of us have failed” 
(see Gide and Rist, page 141, foot-note). 

In spite of Ricardo’s confession that he was baffled by the problem of 
value, the labor theory of value continued to do service for the greater 
part of the nineteenth century. In fact it must be blamed for no small 
amount of mischief in industrial and social relations. 

The labor theory of value became the foundation of the utopian experi¬ 
ments sponsored by Robert Owen. The most interesting of these for us is the 
National Equitable Labour Exchange. Robert Owen is said not to have been 
proud of his association with that experiment. Yet it represented a direct 
effort to force goods to exchange at what was conceived to be their real 
value—the amount of labor expended in their production. Members of the 
exchange were to bring goods tagged as to the number of hours expended in 
their production. The assumption was that they would exchange for goods 


NORMAL VALUE 


91 


of a different kind which represented the same expenditure of effort. Thus 
if producers could once be brought into complete accord, money would 
be dispensed with, profits would disappear, and the value of each com¬ 
modity would be merely the number of hours expended in its production. 
The experiment failed for the very simple reason that it was founded on an 
erroneous theory of value. 

It is a well known fact that Marxian socialism is founded on the labor 
theory of value. Not satisfied merely with starting little social nuclei, as 
Owen attempted to do, which were supposed to expand until they displaced 
the old order, Marx desired to see—in fact foresaw the approach of a new 
order—an order in which distribution would be accomplished on the basis 
of labor exerted in the production of goods. Assuming that the surplus-value 
concept was scientifically accurate, Marx prophesied that the established order 
would bring about its own destruction. The surplus value was supposed to 
exist because goods sell on the market for more than the amount expended 
for labor on their production. The difference between the amount for which 
they sell and the amount paid for the labor employed in their production 
measures the surplus value. The surplus value is, Marx assumed, that on 
which the capitalists live. Some day, according to Marx, the laborers are go¬ 
ing to arise in their dignity and confiscate the factories, abolish the capitalists, 
and distribute the products on the basis of their value—the amount of labor 
expended on their production. The absurdity of the Marxian hypothesis is 
shown by the absurdity of the labor theory of value. 

The commercial world is still worried over an explanation of value which 
can be employed in connection with everyday affairs. A recent decision of 
the United States Supreme Court—the O’Fallon case (279 U. S. 461) — 
shows that. This is true in spite of the fact that a great deal of work has 
been done in the direction of clarifying the subject since the time of Ricardo. 
Many other illustrations can be found in commercial life of minds baffled 
by the riddle of normal value. The recency and the magnitude of the 
O’Fallon case, give it especial interest to us. It relates to the effort of 
the United States Interstate Commerce Commission to find a basis in the 
physical valuation of the railroads for a reasonable determination of rates. 

An assumption is made, that a railroad tariff schedule which makes 
possible an interest return of 5 *4% or 6% on the value of the investment 
would be a fair rate. Therefore, for abut fifteen years, the Interestate Com¬ 
merce Commission has been spending millions of dollars in an attempt to find 
out what that value is. After an approximate completion of the task, their 
method of determination of this value has been challenged in the Supreme 
Court. The court has held that in making the valuation proper account was 
not taken of the cost of reproduction. What that means with regard to the 
future work of the Commission remains to be seen. For us, however, it serves 


92 


THE EXPANSION OF ECONOMIC CONCEPTS 


as an excellent illustration of the current lack of clarity in the conception 
of normal value. 

If the economic theory of value cannot throw light on problems like that 
it is as yet far from satisfactory. With that in mind let us examine contribu¬ 
tions which have been made to the theory of value since Ricardo. 

Post-Ricardian Concepts of Normal Value. John Stuart Mill and 
the Concept of Normal Value .—Just as Mill made only a slight advance over 
his predecessors with regard to the theory of market value, similarly so with 
the theory of normal value. He took Ricardo to task for considering labor 
alone as the source of value. He further recognized that the valuation process 
had to be applied differently to different productive situations. The following 
quotation will present Mill’s point of view: 

"To recapitulate: demand and supply govern the value of all things which 
cannot be indefinitely increased; except that even for them, when produced 
by industry, there is a minimum of value, determined by the cost of produc¬ 
tion. But in all things which admit of indefinite multiplication, demand 
and supply only determine the perturbations of value during a period which 
cannot exceed the length of time necessary for altering the supply. While 
thus ruling the oscillations of value, they themselves obey a superior force, 
which makes value gravitate towards Cost of Production, and which would 
reach it and keep it there, if fresh disturbing influences were not continually 
arising to make it again deviate. To pursue the same strain of metaphor, 
demand and supply always rush to an equilibrium, but the condition of stable 
equilibrium is when things exchange for each other according to their cost 
of production, or, in the expression we have used, when things are at their 
natural value.” (Concluding paragraph, Vol. I, Book III, Chap. II, Principles 
of Political Economy.) 

In recognizing cost of production as the source of normal (natural) 
value, Mill showed an advance over Ricardo. In making the distinction 
between freely reproducable goods and goods not freely reproducable he 
struck a note which has been played upon extensively since. But in this 
matter as in many others Mill starts a line of inquiry without being able to 
follow it out to it# logical conclusion. 

Bastiat and the Service-Value Concept. —Contemporaneously with Mill, 
the labor theory of value was being challenged from another point of view. 
This challenge was made by a genial Frenchman, Frederick Bastiat. Bastiat’s 
thesis was that the labor theory of value was too evidently in conflict with 
the facts to be true. "Such a theory could never explain why the value of a 
pearl accidently discovered should equal the value of another labouriously 
brought from the depths of the sea.” Consequently Bastiat developed a theory 
which he thought removed that inconsistency. That was his famous service- 


NORMAL VALUE 


93 


value theory. "Value is the ratio between two exchanged services. The dia¬ 
mond is more valuable than water because the person who gives it to me is 
rendering me a greater service than he who merely gives me a glass of water.” 
The value of a thing not being determined by the amout of labour which was 
spent on its production, must be determined by the amount of labor which 
it would have been necessary to spend had it not been procured with less 
labor. 

All of which goes to show how confused was the concept of value for 
many years after Ricardo. 

The Neo-Classical Economists and Normal Value. —It cannot be 
said that all of the neo-classical economists have been able to free themselves 
from the confusion that existed in classical authorities with regard to normal 
value. Not a few current texts show slight advance over the work of John 
Stuart Mill. Others have been so much carried away with marginalism and 
mathematical formulae that they have lost their poise with regard to the 
fundamental characteristics of value. Several of the purely mathematical 
economists have even dared to suggest that there is no such thing as normal 
value. No less an authority than Stanley Jevons suggested that the word 
value be dropped from the vocabulary of economics and the expression ratio 
of exchanges be substituted for it. "Value itself, the pivot of Classical eco¬ 
nomics, is simply a link in exchange . . . and since it is not a thing at all, 
but merely an expression, it would be ridiculous to struggle to find its cause, 
or nature, as the older writers did.” (Quotation from Gide and Rist, p. 530, 
footnote.) 

The only interpretation logical for a statement like that is that price— 
market price—covers the whole subject of value, a point of view that is far 
from tenable. It should be added, however, that the marginal concept, made 
so much of by the Austrian branch of the Neo-Classicals has done great 
service in helping to clarify the subject of normal value. 

Alfred Marshall's Contribution to the Theory of Normal 
Value. —Ricardo’s sigh for an abler pen appears to have been answered in 
the person of Dr. Alfred Marshall, also an English authority. Marshall is 
among the best of the mathematical economists, but the assumption made by 
other mathematicals that the pursuit of the foundation of normal value was 
a futile pursuit, was not shared by him. Instead he took up the problem 
where Mill had left off. The result is that Professor Marshall has made a 
greater inroad into the wilderness of value than any other authority. For 
that reason Marshall’s analysis is presented here as the currently accepted 
theory. 

Definition of Normal .—The early classical economists were satisfied with 
£ mere statement that the market value tended to oscillate above and below 


94 


THE EXPANSION OF ECONOMIC CONCEPTS 


the "natural” value—the "natural” value being determined by the cost of 
production (as presented by Mill). This analysis was incomplete in at least 
two respects. The concept of the natural, or normal, was extremely vague, 
and the concept of cost of production was even more chaotic. Marshall 
proceeds to clarify these concepts. 

He begins by show that the term normal itself needs definition. We shall 
give his own language here: "In this case, as in others, the economist merely 
brings to light difficulties that are latent in common discourse of life, so that 
being frankly faced they may be thoroughly overcome. For in ordinary life 
it is customary to use the word normal in different senses with reference to 
different periods of time; and leave the context to explain the transition from 
one to another. The economist follows this practice of every-day life; but by 
taking pains to indicate the transition, he sometimes seems to have created a 
complication which in fact he has only revealed. 

"Thus, when it is said that the price of wool on a certain day was abnor¬ 
mally high though the average price for the year was abnormally low, that 
the wages of coal miners were abnormally high in 1872 and abnormally low 
in 1879, that the (real) wages of labour were abnormally high at the end of 
the fourteenth century and abnormally low in the middle of the sixteenth; 
everyone understands that the scope of the term normal is not the same 
in these various cases.” (Principles , p. 363.) 

"Four classes stand out. In each, price is governed by the relations 
between demand and supply; as regards market prices, Supply is taken to 
mean the stock of the commodity in question which is on hand, at all events 
in sight: as regards normal prices, when the term normal is taken to relate to 
short periods of a few months or a year, supply means broadly what can be 
produced for the price in question with the existing stock of plant, personal 
and impersonal, in the given time. As regards normal prices, when the term 
normal is to refer to long periods of several years, supply means what can be 
produced by the plant, which itself can be remuneratively produced and 
applied within the movement of normal price, caused by the gradual growth 
of knowledge, of population and of capital, and the changing conditions of 
demand and supply from one generation to to another.” {Ibid. pp. 378-9.) 
The fourth refers to secular trends. 

In fact, therefore, the term market value means just one demand and 
supply relationship, whereas the term normal value may mean any one of 
several. Marshall goes into an extended discussion, giving illustrations of the 
short-and-long-period normals. The student is strongly urged to read the 
whole of Chapter V, Book V, on this point. Suffice it for us to say here that 
the more remote forces are at work in the determination of long-term normals 
than in short-term normals. The general phenomenon of the oscillation of the 


NORMAL VALUE 


9 $ 


market value above and below the normal remains in evidence. The forces at 
work to counteract this oscillation are more illusive. 

It may further be said that the period of time of a short-period normal 
for one commodity may ,be a long-time normal for another. The response in 
production of a commodity like cotton or wheat to a high or low price may 
be seen from year to year, whereas in a commodity such as citrus fruit it 
takes more nearly a ten-year interval for the responses to work themselves 
out. 

The Theory of Changing Normals .—The existence of the fact of a normal 
does not mean that the normal itself is constant. The phenomenon is not 
unlike the relation of the earth to the sun, and in turn the relation of the sun 
and the planets to the rest of the universe. We are told by astronomers that 
although there is a normal relationship between the planets and the sun yet 
the constellations themselves are not stationary. Similarly so for the phe¬ 
nomena of value. The condition of supply and demand may bring into exis¬ 
tence a different normal from that which had previously been established as 
an equilibrium of supply and demand. 

Professor Marshall is careful to observe that different phenomena prevail 
with regard to a changing normal demand from those which prevail in the 
case of a changing normal supply. 

"Here there is to be noted an important difference between demand and 
supply. A fall in the price at which a commodity is offered, acts on demand 
always in one direction. The amount of the commodity demanded mav 
increase much or little according as the demand is elastic or inelastic: and 
a long or short time may be required for developing the new and extended 
uses of the commodity, which are rendred possible by the fall in price. But 
at all events—if exceptional cases in which a thing is driven out of fashion 
by a fall in its price be neglected—the influence of price on demand is 
similar in character for all commodities: and, further, those demands which 
show high elasticity in the long run, show high elasticity almost at once; 
so that subject to a few exceptions, we may speak of the demand for a com¬ 
modity as being of high or low elasticity without specifying how far we are 
looking ahead. 

"But there are no such simple rules with regard to supply. An increase in 
the price offered by purchasers does indeed always increase supply; and thus 
it is true that, if we have regard to short periods only, and especially to the 
transactions of a dealer’s market, there is an 'elasticity of supply’ which cor¬ 
responds closely to elasticity of demand. That is to say, a given rise in price 
will cause a great or small increase in the offers which sellers accept, accord¬ 
ing as they have large or small reserves in the background, and as they have 
formed low or high estimates of the level of prices at the next market: and 
this rule applies nearly in the-same way to things which in the long run have 




96 


THE EXPANSION OF ECONOMIC CONCEPTS 


a tendency to diminishing return as to those which have a tendency to 
increasing return. In fact if the large plant needed in a branch of manufac¬ 
ture is fully occupied, and cannot be rapidly increased, an increase of the 
price offered for its products may have no perceptible effect in increasing 
the output for some considerable time: while a similar increase in demand 
for a hand-made commodity might call forth quickly a great increase in 
supply, though in the long run its supply conformed to that of constant 
return or even diminishing return.” (Ibid. p. 456.) 

(1) Change in Normal Demand Analyzed .—The existence of a normal 
value of any commodity assumes given supply and demand schedules. If the 
amount which will be taken at the varying prices increases or decreases we 
have the phenomenon of a changing normal demand. The change may be in 
either direction. Goods which partake of the nature of fads suffer more from 
this prenomenon than those which supply more fundamental needs. The 
demand for hat pins, for instance, is certainly less than formerly, as is true of 
hair nets, and many other things which once were essentially a part of 
women’s apparel. Usually when the demand for one commodity declines it is 
accompanied by an increase in the demand for another. This is not likely 
to be as true of fads as it is of things of more fundamental importance. The 
last decade has experienced a drastic decline in the demand for coal. Hence 
the normal value of coal is less than formerly, due to no particular increase in 
the cost of producing coal. This has been true in spite of the fact of an 
increase in the demand for the service which coal once performed. In this 
instance a decrease in the demand for coal has been accompanied by an 
increase in the demand for oil and its products, for natural gas, and for elec¬ 
tricity. 

We are likely to think that an increase in the demand for a commodity 
will have the effect of always increasing its normal value. That is not neces¬ 
sarily the case. It frequently happens that many units of a good can be sold 
at a smaller figure per unit than a few of the same kind. To understand this 
we must consider whether or not the goods produced are produced at a 
constant cost, at an increasing cost, or at a decreasing cost. 

Goods are produced at a constant cost when each increment is produced 
at same cost. A large amount cannot be produced any more cheaply per unit 
than a small amount, nor will it be produced at any greater cost. An increase 
in the demand for goods of that kind will have no effect on their value. 
One unit can be sold as cheaply as each of one hundred. There are not a 
great many illustrations of goods produced at constant cost. Usually they be¬ 
long to the class of commodities resulting from handicraft. The basket-maker, 
for instance makes his baskets at very nearly constant cost. If the demand 
for his baskets should double it is not likely that the price would go up. 

The influence of an increasing demand for goods produced at decreasing 


NORMAL VALUE 


97 


cost needs to be considered next. The manufacture and sale of books is an 
illustration of goods produced at decreasing cost. It is a well-known fact that 
law books are expensive because of the limited demand for them. If law books 
could have the demand that exists for popular novels the price of law books 
would fall greatly. It is a well-known fact that the more books that can be 
sold the lower the price. This phenomenon continues until the cost of each 
book becomes constant. After that point is reached an increase in demand 
obeys the law of constant cost instead of of decreasing cost. 

Other goods are known to obey the law of increasing costs. A standard 
illustration is that of the telephone business. The connections at the central 
office grow geometrically as the subscribers increase; i. e. each additional 
subscriber means a multiplication of connections to be made instead of a 
mere addition. This fact has given rise to the necessity of raising the rentals 
for telephone service as cities have grown. Owing to the further fact that 
there appears to be no point at which this increasing cost dissipates itself 
into a constant cost, in the great metropolis it becomes necessary to abandon 
the flat rate in many instances and make the charges by the call instead. The 
increase in demand for commodities which obey the law of increasing costs 
can have no other influence than that of increasing the normal value. 

For each of the situations just described the counterpart prevails. The 
reduction in demand for goods obeying the law of constant cost would 
naturally not influence the price. One will be sold at the same price as each of 
a dozen. For goods obeying the law of decreasing costs a decline in demand 
should cause an increase in price and for those obeying the law of increasing 
costs a decline in demand should cause a fall in price. 

(2) Change in Normal Sttpply. —It is just as certainly possible for the 
demand to remain unchanged while there is a change in the method of pro¬ 
duction as it is for there to be a change in demand. The problem for us to 
consider here is the effect of a change in the method of production on the 
normal-supply price, or normal value. 

(a) Goods Produced at Constant Cost. —It is easy to see that any lower¬ 
ing of the cost (or increase for that matter) of goods produced at constant 
cost would influence the value by the amount of the change. If the basket- 
maker invents a tool for splitting switches that enables him to make baskets 
twice as rapidly he can afford to sell them for exactly half as much as 
formerly. If the government places a tax of, say, fifty cents on each basket 
he will be forced to charge exactly fifty cents more for each basket. Which¬ 
ever way the cost goes for goods produced at constant cost it may be 
expected to be reflected in the value of the commodity. 

(b) Goods produced with Increasing Costs. —The effect of an improved 
method that lowers the expense of producing goods produced with increas¬ 
ing costs cannot be readily stated. Neither can the reverse, that of an 


98 


THE EXPANSION OF ECONOMIC CONCEPTS 


increased expense. If, however, the saving or increase is a definite ascertain¬ 
able amount the problem is not so difficult. Professor Marshall uses a tax 
and a bounty for an illustration. "A tax by raising its price, and diminishing 
its consumption, will lower its expense of production other than the tax: 
and the result will be to raise the supply price by something less than the 
amount of the tax.” (p. 468.) This is but another way of saying that each 
additional unit of a commodity which is produced at increasing expense is 
produced at greater cost than those preceding. A reduction in sales due to an 
increased expense, such as a tax, cuts off the production of goods produced at 
a greater expense than those actually sold. That saving subtracted from the 
total increased charge measures the effect of an increased cost of production 
on the normal value, or price. 

Professor Marshall represents the opposite point of view—that of a 
lowering of the expense of production—by a bounty. "On the other hand, 
a bounty on a commodity which obeys the law of diminishing returns (in¬ 
creasing expense) will lead to increased production, and will extend the 
margin of cultivation to places and conditions in which the expense of pro¬ 
duction, exclusive of the bounty, is greater than before. Thus it would 
lower the price to the consumer . . . less than if it were given for the 
production of a commodity which obeyed the law of constant return.” 
(pp. 468-9). In other words, since each unit produced is produced at an 
increased expense a stimulation of production would mean that each addi¬ 
tional unit produced as a result of that stimulation would cost more than 
each of those previously produced. This extra charge would have to be 
subtracted from the amount of saving due to an invention, say, or a bounty, 
in order to secure a measure of the effect of the saving on normal value, 
or price. 

(c) Goods Which Obey the Law of Decreasing Expense .—A similar 
reasoning applies to goods which obey the law of decreasing expense. An 
extra charge, say a tax—will increase the price by more than the amount 
of the tax. That is true because the reduction in sales due to the higher 
price cuts production at the point where goods are produced more cheaply 
than those actually offered on the market. The amount of this loss will have' 
to be added to the extra expense. Thus the normal value will be increased by 
the amount of the loss due to the reduction of output, plus the extra charge 
—say a tax. 

On the other hand a bounty, or other saving, would lower the value con¬ 
siderably more than the amount of the saving. That is true because the 
stimulation of sales growing out of the reduced price will result in the pro¬ 
duction of goods at a less relative cost than any of those previously produced. 
The amount saved on the newly stimulated production in addition to the 


NORMAL VALUE 


99 


amount of the bounty will have to be subtracted from the previous normal 
value in order to ascertain the new normal. 

Thus we see that the mere statement that the market value oscillates 
above and below a normal value is only a beginning of the comprehension of 
normal value. The term normal must itself first be defined. After it has 
been defined it cannot be considered as fixed. It is hardly necessary to allude 
to a further complication. Our assumption that the demand schedule remained 
constant while the supply schedule was changing, or vice versa, is itself far 
from a true picture of the behavior in the markets. Any assumption of the 
constancy of either while the other is changing is a mere assumption, for 
the demand schedule may be changing at the same time as the supply sched¬ 
ule is changing. When we consider problems like this we are reminded again 
that economics is a complex science. 

Correlation Between Market Value and Normal Value. —Al¬ 
though the above concepts are helpful in gaining an understanding of the 
relation between the cost of production and normal value, yet they do not 
give a completely satisfactory solution to the problem. The mere fact that a 
concern produces at constant, increasing, or decreasing cost, is in and of 
itself, not enough to show the relation of cost of production to value. The 
fact is that two firms seldom operate at exactly the same expense under any 
circumstances. This raises the question of the beginning and ending and 
continuation of business projects. It is here that we find the real connection 
between cost of production and normal value. The problem is a difficult one, 
especially because of the intangibility of its data. We can not find our way 
out except in the light of the marginal concept—a concept which we have 
found did much service in the market-value analysis. 

All of us know that when prices are high new firms tend to enter the 
field. When prices are low businesses fail. It is almost invariably those firms 
which open up during a period of high prices that fail when prices go down. 
We call these the marginal firms. They can barely afford to produce the goods 
at the prevailing price. We have already met them in our discussion of 
market value. If prices remained unchanged these marginal firms might 
remain in existence. But prices do not remain steady. Hence those firms 
which cannot afford to stay in business except when prices are high, fail 
when prices fall. 

This leads us to say that, as the markets are now organized, there are two 
sorts of changes. The general rise and fall in prices—known as cyclical 
changes—is one. The rise and fall in the prices of individual commodities is 
the other. For the purpose of understanding the relation of cost of produc¬ 
tion to value it is necessary to assume production and distribution to be free 
of general price changes. We have the right to make that assumption because 


100 


THE EXPANSION OF ECONOMIC CONCEPTS 


of the fact that general price changes in and of themselves have no effect 
on value. A period of rising prices may have a tonic effect on business, and 
a period of falling prices may be deadening in its effect on business. In their 
ultimate analysis, however, values in exchange are merely ratios. A general 
price rise does no more than increase both the numerator and denominator the 
same amount. A general fall, likewise, only decreases them to the same extent. 
Hence we have a right to assume, for purposes of scientific analysis, that 
prices as a whole are constant. If that were true would market prices and 
normal prices be the same? Unfortunately, not necessarily so. We still would 
be faced with the problem of changing normals, growing out of the changes 
relating to individual commodities. 

If a new fad developed, the market price of that thing would for a time 
be high. As productive agencies fitted themselves into the scheme of things 
so that the new demand could be catered to, then the phenomenon of normal 
value would begin to appear. The price would tend to adjust itself in accord¬ 
ance with whether or not the goods were produced with constant, increas¬ 
ing, or decreasing expense. Then suddenly the fashion might change and 
persons who had invested their capital and energies in preparing to supply 
that commodity would be left to seek their own salvation. And so the 
process continues. The relation of cost of production to value is, therefore, 
an illusive thing. It is because of the very illusiveness of the thing that 
economists have found it necessary to make a further assumption for study¬ 
ing the relation of cost of production to value. This assumption is that of 
a state of normal equilibrium. 

The State of Normal Equilibrium .—At the state of normal equilib¬ 
rium progress is supposed to have stopped. The exasperating disturbances of 
everyday life are supposed to have ceased so far as they affect business. Produc¬ 
tion, distribution, and consumption are at an even keel. With an assumption 
of that kind it becomes possible to study the relation of cost of production 
to value. The only value that could be present at a state of normal equilib¬ 
rium would be normal value. At that state the variations from the normal 
are assumed to have ceased. 

Owing to the fact that different firms produce at different expenses of 
production it becomes necessary to enquire as to the expenses of production 
of what firm, after all, it is that determines the value. Clearly if normal value 
were measured merely by the cost of production it might be any amount. 
The expense of production of cotton, say, on some farms, might easily be 
fifty cents a pound. Even the most superficial observer knows without being 
told that fifty cents a pound does not represent the normal value of cotton. 
It might further be observed that under other conditions cotton could profit¬ 
able be produced at, say, five cents a pound. Clearly, also, five cents a pound 
is not the normal value of cotton. Since on the very face of the matter the 


NORMAL VALUE 


101 


cost of production of any particular producer cannot represent the normal 
value, we must look deeper and enquire which cost of production determines 
normal value. The economist has given the answer that it is the cost of pro¬ 
duction of the representative firm. 

We have found the marginal producer illusive in nature but certain of 
existence. The representative firm is best thought of as the marginal pro¬ 
ducer over long periods of time, the length of the period being determined by 
which different aspect of the normal one has in mind. 

Professor Marshall describes it as follows: "Thus the history of the 
individual firm cannot be made into the history of an industry any more 
than the history of an individual man can be made into the history of 
mankind. And yet the history of mankind is the outcome of the history of 
individuals; and the aggregate production for a general market is the out¬ 
come of the motives which induce individual producers to expand or contract 
their production. It is just here that our device of a representative firm 
comes to our aid. We imagine to ourselves at any time a firm that has 
its fair share of those internal and external economies, which appertain to 
the aggregate scale of production in the industry to which it belongs. We 
recognize that the size of such a firm, while partly dependent on changes in 
technique and in costs of transport, is governed, other things being equal, 
by the general expansion of the industry. We regard the manager of it as 
reckoning up whether it would be worth his while to add a certain new line 
to his undertakings; whether he should introduce a certain new machine 
and so on. We regard him as treating the output which would result from 
that change more or less as a unit, and weighing in his mind the cost against 
the gain. 

"This then is the marginal cost on which we fix our eyes. We do not 
expect it to fall immediately in consequence of a sudden increase of demand. 
On the contrary we expect the short-period supply price to increase with 
increasing output. But we also expect a gradual increase in demand to 
increase gradually the size and efficiency of this representative firm; and to 
increase the economies both internal and external which are at its disposal.” 
(pp. 459-60.) 

The difficulty of spotting the representative firm in actual life leads 
economists to look for it at the state of normal equilibrium. At that state 
this difficulty does not exist. Under a regime of free competition and indus¬ 
trial progress production is always tending to seek that equilibrium. It is the 
fact of the representative firm that is responsible for that tendency. Because 
of that fact market value cannot for any great length of time remain very 
far above or below the normal value, although seldom if ever does it exactly 
correspond to that value—the expenses of production of the representative 
firm. 


102 


THE EXPANSION OF ECONOMIC CONCEPTS 


Normal Value and Fair Price. —Although of preeminent importance 
in the comprehension of the economic theory of normal value, the represent¬ 
ative-firm concept dees not get us far in the solution of the problem of 
a fair price. That is to say, it at best reveals the fact that any effort to choke 
down forces of competition and arbitrarily determine a fair price calculated 
on cost of production is from the first destined to fail. No wonder that 
after spending over $15,000,000 of the government’s money, and, (accord¬ 
ing to the editor of The Railway Age) $115,000,000 of the railroads’ money, 
and after more than fifteen years’ study, the Interstate Commerce Commis¬ 
sion is far from a satisfactory solution of the problem of the valuation of 
the railroads of the United States. 

We should not close this chapter, however, without some comment on 
what light the economic theory of normal value throws on the practical 
problem of valuation. In a problem like that we have in clear foreground the 
question of what after all is fair in valuation. 

The starting point in the economic theory of value is economic freedom 
—that which is usually referred to as free competition. This means that the 
business man is left free to expand and contract his business as prompted 
by the profit motive in response to the market. The Interstate Commerce 
Commission, by force of circumstances, had to begin with a denial of that 
assumption. Their problem was instead to ascertain how much the railroads 
were worth with the view of making the railroad tariffs yield a fair return 
on that valuation. It is only in connection with the problem of what con¬ 
stitutes a fair interest rate on the capital invested that the work of the 
Commission touches the theory of normal value. Strange as it may seem, 
no serious dispute has arisen over that point. The commission has simply 
assumed that 5 l /i% or 6% is about all that those who furnished the capital 
should receive. The transportation act sets a limit of six per cent, as a sort 
of maximum above which the Commission can confiscate at least half of 
the income for the creation of a revolving fund to help out weaker roads. 
All of which goes to show that the normal rate of interest on capital invested 
in railroads is not more than six per cent. Enough capital could be secured 
at that figure to do the work needed to be done. The economic laws have 
so well answered the question as to what is the normal and fair return on 
capital invested in railroads that little if any controversy has risen regarding 
it. 

The Commission must have faced a similar problem with regard to wages, 
management, and rents. But not a great deal has been said about these charges. 
The question of what constitutes a normal wage, a normal salary, and fair 
rents, being much more complicated than that of the normal interest rate, 
the more deeply they have dug into these problems the more baffled they must 


NORMAL VALUE 


103 


have become. In economic theory these problems are studied under the gen¬ 
eral heading of distribution. 

By way of further comment, it should be said that as the valuation of 
railroads is a problem growing out of a monopoly, it is simpler than would 
be the case if an attempt were made to set a fair value on goods produced 
under competition. Any basis for a charge made by a monopoly other than 
that of the economic law of the monoply price has to be more or less arbi¬ 
trary. In many instances—particularly that of real estate values—the value 
itself is the result of any rate which is set, rather than the basis of a rate to 
be set. 

But if the Commission realizes that the problem before them is a 
monopoly problem, and that many values which they are attempting to 
discover are the result of rather than the basis of the rate to be set, they are 
not faced with an impossible problem. As long as the railroads continue to 
yield a substantial income—as long as a monopoly profit is possible—eco¬ 
nomically speaking, the problem facing the Interstate Commerce Commis¬ 
sion is not materially different from that faced by the former railroad direc¬ 
tors. Each has to fix a rate in accordance with the principle of what the 
traffic will bear. However much they may attempt to free themselves from 
the operation of that law they cannot do so. The fundamental difference 
between the behavior of the Commission and that of the directors of the 
railroads is that the Commission has the point of view of the public. The 
Commission at least attempts to go from actual cost to a rate which will 
give a recognized return on that cost, whereas the directors tended to go for 
income in disregard of valuation. The concern of the Interstate Commerce 
Commission, however, cannot logically be with original cost for the original 
cost will in a very real sense not be an accurate measure of the value of the 
roads. It might represent exceptional skill in planning expenditures, or it 
might represent a wasteful expenditure of funds. I am sure that if the build¬ 
ers had been able to drive good bargains they would feel severely affronted 
if that fact were not recognized in valuation. On the contrary a wasteful 
expenditure would be hard to uncover. The original cost hunt would be futile 
from the start. No one should even assume that it would be wise to reproduce 
the roads as they were. Hence the "cost of reproduction” chase would be even 
more hopeless. If possible it would be so highly undesirable as to be foolish 
in suggestion. 

The real problem in seeking a valuation of something of the nature of 
the railroads is that of the size of the various reserves to be set up, from 
the income. The main one of these is that of replacement. If a railroad 
system has a reserve large enough to keep it intact it has no cause for com¬ 
plaint. Although a problem of some difficulty, it is as nothing as compared 
with the problem of finding out original cost or cost of reproduction. The 


104 


THE EXPANSION OF ECONOMIC CONCEPTS 


railroads, as already noted, do not need to be reproduced, they need to be kept 
up-to-date—efficient in operation. A careful budgeting of expenditures for 
various items of maintenance and replacement will very soon give a reasonable 
basis for determining the size of that reserve. It will also show—a thing of 
no minor importance—whether or not any particular railroad needs to be 
kept up at all. 

Having made a careful study of necessary reserves, the salary and wage 
items, and the problem of rents are settled on a bargaining basis. Persons 
employed in a monopoly are expected to receive somewhat more than workers 
of the same grade in other types of industry. The question of rents connects 
up intimately with other governmental problems. The objective is to keep the 
charge as low as possible. 

In conclusion, then, what light does all this throw on the question of 
what is and what is not a fair normal price? We arrive at the same answer 
as that which was given to the question of a fair market price. It is simply 
the price which would result from balancing the supply schedules against 
the demand schedule in an open market. It is only when the market threatens 
to become closed that the question of what is a fair normal price comes up. 
When that happens the solution is if possible to break the obstructions. If a 
business is necessarily a monopoly on account of some natural condition, then 
the regulation of the charges by a governmental agency comes into play. 
But this body has to operate within the province of the economic law of 
monopoly price. Since, however, their point of view is that of the public 
instead of that of the private interests, the standards of fairness set by them 
will certainly be more conducive to the ultimate happiness of the people than 
would be true if the monopolists were allowed to exact the amount which 
they could do if left unmolested. 


Note: The following suggestions are given as helpful in making application of the 
principles herein brought out to a problem like that of the valuation of railroads: 

1. Since the values are to a large extent the result of the rates set by the Commission, 
an effort made by the Commission to discover the value of the railroads amounts to reasoning 
in a circle. How could they ever discover value by looking at the properties when their 
values have been determined by that which they are seeking to base the result of their 
search on? Can they set a rate based on the value of a thing that is determined by the 
rate set? 

From this it results that the valuation process has to begin with the rate set instead of 
with the railroad property. 

2. Railroad rates conform to the law of the monopoly price. The Commission, there¬ 
fore, is as much at the mercy of the situation as the directors in finding the proper rate to 
be charged. The Commission, therefore, can only arrive at their solution of the problem by 
charging what the traffic will bear. 

3. In arriving at the monopoly price the charges made by the Commission, since it 
is representative of the public interest instead of that of the railroads, are more likely to be 
uniformly just and indiscriminatory than that set by the directors. The Commission, there¬ 
fore, certainly justifies its existence by insisting on equitable adjustment of the charges made. 


NORMAL VALUE 


105 


4. In dissecting the income for the purpose of arriving at a solution of their problem 
of valuation the Commission must look out for: 

(1) Salaries and wages.—We have already noted that these have already been determined 
in the competitive market. The problem of how much has to be paid to secure the services of 
laborers of certain classes is simply that of what the market affords. The only complication 
here relates to the matter of collective bargaining through the unions. As a rule unions 
are reasonably responsive to equitable decisions as to what their services are worth. If the 
union has already set their wages the problem becomes simplified rather than more complicated 
by the fact of unions. At any rate the charges for salaries and wages are determined for the 
commission instead of by them. 

(2) Interest on actual capital invested in the railroads.—The problem of arriving at a 
reasonably accurate figure with regard to how much actual money has been invested in the 
stocks and bonds of railroad companies is by no means a baffling one. The outstanding bonds 
speak for themselves. Although the stock may be watered, yet a reasonably accurate par 
value can be given to each share of stock and thereafter that valuation could be allowed to 
stand. Having arrived at a solution of that problem the matter of crediting from the income 
an amount to cover, say, five per cent on the bonds and six per cent on the established r°r 
value of the stock becomes a definitely tangible proposition. 

(3) Reserves and replacements.—Exactly what reserve accounts need to be set up are 
fairly well known. The main problem of valuation of the equipment relates to the matter 
of depreciation and replacement. It is here that all of the talk about original cost and cost of 
reproduction takes form. It is easily seen that original cost is of little test in determining 
value. Similarly the cost of reproduction is of small significance. Few, if any, pieces of 
equipment should be replaced. The real problem is that of keeping the roads intact. They 
must be kept up to a point of maximum efficiency. We have here the problem of correct 
reserves and depreciation charges and nothing else. 

(4) Insurance and taxes.—Under the term insurance we include here not only premiums 
that are paid to insurance companies, but accounts that have to be set up to meet charges 
for accidents and breakages. This item represents a heavy charge on railroads. Taxes refers 
to the State and local property taxes and regular charges made by the U. S. Government. 

(5) Remainder available for betterments, and revolving funds.—Some railroads may not 
make expenses. If they do not pay expenses and can not be reasonably brought out of the 
hole, there is only one thing to do, and that is to scrap them. Others may be temporarily em¬ 
barrassed. These the Commission might decide need to be carried from their revolving fund. 
Those railroads which make good surpluses above the legitimate charges should logically be 
called upon to provide the revolving fund from which to carry the unfortunate ones. It 
would seem that the authors of the Transportation Act were feeling for that principle when 
it provided for a recapture of fifty per cent of all that the more successful roads made above 
six per cent on their valuation. 

In competitive markets the normal values are self-determinative. In a 
monopoly the government can well afford to attack the problem of valuation. 
But care must be exercised to attack it from the standpoint of income instead 
of from that of physical valuation. 




John Stuart Mill 


"John Stuart Mill, born in 1806, was the son of James Mill, the economist of whom we 
have already spoken. The system of education which his father planned for him can only 
be described as extraordinary. Practised on anyone else it would have been fatal. At the age 
of ten he was already well versed in universal history and in the literatures of Greece and 
Rome. At thirteen he had a fair grasp of science and philosophy, and had written a history 
of Rome. By the time he was fourteen he knew all the political economy that there was to 
know then. In 1829, then a young man of twenty-three, he published his first essays on 


107 




















108 


THE EXPANSION OF ECONOMIC CONCEPTS 


political economy. In 1843 appeared his well-known System of Logic, which immedately 
established his fame. In 1848 he issued the admirable Principles of Political Economy. Mill was 
in the service of the East India Company up to the time when it lost its charter in 1 8 58. 
From 1865 to 1868 he was a member of the House of Commons. After the death of his 
wife, who collaborated with him in the production of several of his works, especially Liberty 
(18 59), being unwilling to quit the spot where she lay buried, he spent the last years of his 
life, except those taken up by his Parliamentary work, at Avignon. His autobiography con¬ 
tains a precious account of his life and of his gradual conversion to socialistic views.”—Gide 
and Rist: History of Economic Doctrines, p. 3 52, note. 

When we contemplate the full significance of John Stuart Mill’s treatise on political 
economy we are forced to conclude that its chief merit lies in its fine passages, which are in 
the main restatements of conclusions already held by preceding authorities. It was of great 
significance, nevertheless, to bring together in one work the whole of the science of economics 
as it was understood in his time. 

Aside from the brilliant statements of doctrines already accepted Mill made two con¬ 
tributions to economic theory of significance. The one related to the importance of dis¬ 
tinguishing between market value and price. He showed that value is as much a function of 
price as is price a function of value. In addition, Mill pushed the concept of international 
trade at least one degree further than it had been pushed by Ricardo. To study the theory 
of international trade today without bringing in the treatment of he subject made by Mill is 
simply not to understand the subject clearly. It is because of his connection with the first of 
these propositions that we are placing the picture of Mill at this point in our study. It will be 
seen, however, that his contribution to international trade was an extension of this same thesis. 




CHAPTER VI. 


CORRELATION OF VALUE AND PRICE 

The prime mistake in the consideration of value is that of assuming that 
the phenomenon is singular in nature. Unless efforts at an explanation of 
value are preceded by assumptions of the composite nature of the subject 
under discussion the efforts will very soon become clogged with inconsisten¬ 
cies. 

Yet the fact that value must be split up in order to be comprehended 
may itself lead to illogicalities. One phase cannot be accurately considered 
apart from another for in actuality each and every influence may be asserting 
themselves at the same time. It is only because of the fact that it is humanly 
impossible to consider the various phases together that we make the subdi¬ 
vision for the sake of simplicity. 

In actuality value is a sort of mosaic of the following concept: 

( Value in Use 

Value < ( Market Value 

^ Value in Exchange < Book Value 

I Normal Value 

Price is not correctly considered as value. It is, however, the evidence of 
value. It may represent any or all of the aspects of value unless a thing 
becomes "priceless”. 

In the preceding analysis of value nothing at all was said about book 
value. The fact is that economic theory has been neglectful of the book- 
value concept. The economist is too much inclined to consider book value 
no value at all. The very use of the term assumes a variation from actuality. 
When a purchase is made the book entry may conform colsely to the market 
value of the new commodity. But even at that the invoice value is not an 
accurate guide. The value of the goods for sale is different from the value 
indicated by the invoices. Hence, even for merchandise one must find out 
what sort of entry is meant by the expression book value. 

At any rate as soon as an article begins to lose its character of newness its 
value changes. Accountants attempt, as best they can, by means of deprecia¬ 
tion accounts, to protect the article from loss owing to the tendency of 


109 


110 


THE EXPANSION OF ECONOMIC CONCEPTS 


book values to vary from actual market value. The efforts, however, repre¬ 
sent at best little more than skillful guesses. They do serve, nevertheless, to 
keep the book value from varying dangerously far from actual value— 
whether market or normal. 

It is, however, in book value that market value and normal value are 
reflected through prices. Fundamental to this proposition are certain pre¬ 
liminary concepts. They are: 

Goods .—It is evident that not all things are goods. It is further evident 
that not all goods have value. Clearly, furthermore, some goods may have 
value without price. 

For a thing to be a good it has to be an object of human desire. Yet not 
all desirable things are goods. We cannot speak of friendship as a good. Few, 
if any, sentimental attributes are goods as the word is employed in economics. 
The word, therefore, calls for careful attention. All material desirable things 
are goods. But many material things are not desirable and hence are not goods. 
The fact is that most material things are not the objects of human desire. 
Several words carry no other meaning than to apply to undesirable things. 
Words such as nuisance, pests, weeds, etc., are examples. A strange coincidence 
occurs when some things acquire value because of the fact that they are 
useful in protecting mankind from the effect of something harmful. The 
elimination of the harmful thing would of course destroy the value of the 
things brought into existence to protect humanity from their effects. Prac¬ 
tically all medicines fall into that class. The vocation of rattlesnake farming 
is very apropos. Persons make money growing rattlesnakes for the purpose 
of extracting the poison. The poison thus extracted is employed to develop 
a serum to prevent death from rattlesnake bites. In its application to material 
things, therefore, the term goods includes all of those things which are the 
objects of human desire. This is true even though they are desired only as 
a protection from things which are dangerous. 

No such general statement can be made of non-material things. Probably 
the concept is best understood by employing the term services here instead 
of goods. Certainly all services must be included in our classification of 
desirable things which are called goods. All non-material desirable things 
which are transferable are certainly to be included. Good-will in business, 
copyrights and patents, etc., are illustrations of this. But non-material desir¬ 
able things which are not transferable can hardly be included in our defini¬ 
tion of goods. The term goods therefore applies to all desirable material 
things, and all desirable non-material things which are transferable. Further 
than that we can hardly go. 

Utility .—Not all goods have value. The fact is that those goods which 
are most essential to human existence have, under ordinary circumstances, 
practically no value. Air and water are standard illustrations. It is seriously 


CORRELATION OF VALUE AND PRICE 


111 


to be questioned whether water can be any longer, logically, thus considered. 

Those things which are goods without having value are called free 
goods. Goods which have value are called economic goods. Free goods have 
utility but do not have value. It has taken economists a long time to see the 
distinction between utility and value. That fact is probably due as much 
to the lack of a satisfactory word to express the idea as anything else. The 
term utility is inaccurate. But students of the subject have abandoned the 
search for a better term. Yet attention is always called to the fact that in 
economics the term utility is meant to convey a different meaning from that 
conveyed by the word in ordinary discourse. No moral or ethical connotation 
is implied. It simply means the quality of satisfying a human desire. If things 
have that quality and are transferable whether material or non-material they 
are goods. If they exist in such large quantities that the spontaneous supply 
is in excess of the demand they are free. Goods of this kind are said to 
possess utility but not value. 

Value of the Whole Supply v. the Value of Any Particular Quantity .— 
When it is stated that goods, such as air and sunlight, have no value, it 
should be remembered that reference is made not to the whole stock but 
only to any particular amount—such as a cubic yard. The fact is that a good 
such as air, is, from the standpoint of the whole stock, beyond computation 
in value. Yet if every cubic yard of air were multiplied by the value of 
any particular cubic yard under conditions which prevail in nature the 
product would be zero. 

When the intensity of desire for any particular amount of a good is 
registered at zero the good is said to be without value, regardless of the 
fact that the thing may be indispensable even to life itself. It was the failure 
to distinguish between the desire for any particular amount and the desire 
for the commodity as such that led the early economists into confusion. 
These authorities almost invariably employed the term value in use when they 
meant to say utility , or rather to convey the idea which modern economists 
convey when they employ the term utility. 

Value in Use. —If goods are scarce they have no value. The mere fact 
of scarcity, however, does not give rise to value. It has to be a good (or 
service) that is scarce—a scarce utility—for it to have value. Yet the mere 
fact that an object has value does not mean that it will of necessity have 
value in exchange. Only one person may prize an object—say, the photo¬ 
graph of one’s grandmother—that may be of importance to the person who 
possesses it and to no one else. It has value in use. If more than one person 
wants an object it has value in exchange, and may have price. 

Value in use, is therefore, a good-to-person relationship. It is subjective. 
Value in exchange is a good-to-good relationship. It is objective. 

The Law of Diminishing Utility. —Goods are not equally scarce. By 


112 


THE EXPANSION OF ECONOMIC CONCEPTS 


some benign provision of nature the goods which are most essential to 
human existence are most abundant. Our desire for any particular amount of 
these goods is registered at a very low point. This fact appears in obedience 
to the law of diminishing utility. Each additional unit consumed satisfies a 
less intense desire than the previous one. It is the law of diminishing utility 
that directs our behavior in the acquisition of economic goods. Owing to the 
fact that the necessities of human existence are abundant most of us have 
our desires for these at all times nearly completely satisfied. 

There are some phenomena that seem to contradict the universality of the 
law of diminishing utility. "It is impossible to get too much of a good thing” 
is the popular way of expressing that fact. Yet the fact that we seemingly 
never grow tired of good music or can remain longer in our seats each time 
we hear an opera is no refutation of the law. A cultivated taste requires more 
of the refined things of life to reach the limit of satisfaction. A newly 
awakened desire may induce one to reach more eagerly for each additional 
unit of the precious article. Yet these are not any more the denial of the 
existence of the law of diminishing utility than is the fact that heat rises is a 
refutation of the law of gravity. The law exists in spite of the few cases 
wherein one is able to relieve himself of the force of the law. 

Marginal Utility .—The point at which we cease to consume any par¬ 
ticular good (or service) and proceed to the consumption of another 
marks marginal utility. It is in connection with this concept of the marginal 
utility that modern economic analysis has made a substantial advance over 
the early classical economists. Although the Classicals confused utility with 
value in use, and although they failed to express clearly the law of diminish¬ 
ing utility, all of these concepts are in solution in their writings. But we look 
in vain for any definite suggestion of marginal utility. The introduction of 
that concept has done much for the exactness of economic analysis. 

Marginal utility indicates the intensity of our desire for any particular 
good in relation to any or all other goods. The marginal utility of a free good 
is registered at zero. That is why it is free. Since the marginal utility of 
goods other than free goods is not registered at zero they are not free. We 
consume them only to the point at which the desire for another is as great 
or greater than our desire for any of them. 

Marginal utility connects up more directly with value in use than it does 
with value in exchange. Yet it is because of it that we have the phenomenon 
of trading. It, therefore, operates through value in use to influence value in 
exchange. As soon as the intensity of desire for any particular thing which 
we have been consuming falls below that for another good we immediately 
proceed to look for another good which gratifies a more intense desire. Other 
persons being impelled by a similar motive proceed to do the same thing. 
Thus we have the activities of the market place accounted for. 


CORRELATION OF VALUE AND PRICE 


113 


The Refinement of the Concept of Utility. —The definitions 
which have just been given have become a part of practically every modern 
discussion of economic principles. We have noted, however, that they have 
come slowly. It devolves upon us now to show something of how these defi¬ 
nitions and distinctions found their way into economic analysis. 

(1) The Early Classical Point of View. —The fact that the early classi¬ 
cal economists failed to distinguish between utility and value in use accounts 
for a number of contradictions in their analysis of value and price. Through 
a strange coincidence the inconsistency existed in economic literature for 
more than fifty years. A few quotations will be necessary here to show the 
full import of the point under discussion. The following is taken from 
David Ricardo: 

"It has been observed by Adam Smith that 'the word value has two differ¬ 
ent meanings, and sometimes expresses the utility of some particular object, 
and sometimes the power of purchasing other goods which the possession of 
the object conveys. The one may be called value in use; the other value in 
exchange. The things’, he continues, 'which have the greatest value in use, 
have frequently little or no value in exchange; and, on the contrary, those 
which have the greatest value in exchange, have little or no value in use.’ 
Water and air are abundantly useful; they are indeed indispensable to exist¬ 
ence, yet, under ordinary circumstances, nothing can be obtained in ex¬ 
change for them. Gold, on the contrary, though of little use compared with 
air or water, will exchange for a great quantity of other goods. 

"Utility, then, is not the measure of exchangeable value, although it is 
absolutely essential to it. If a commodity were in no way useful—in other 
words, if it could in no way contribute to our gratification—it would be 
destitute of exchangeable value, however scarce it might be, or whatever 
quantity of labour might be necessary to produce it.” ( Principles of Political 
Economy and Taxation, Chapter I, Section I.) 

Writing over twenty-five years later John Stuart Mill had the following 
to say on the subject: "We must begin by settling our phraseology. Adam 
Smith, in a passage often quoted, has touched upon the most obvious am¬ 
biguity of the word value; which in one of its senses, signifies usefulness, 
in another power of purchasing; in his own language, value in use and 
value in exchange. But ... in illustrating this double meaning, Adam Smith 
has himself fallen into another ambiguity. Things (he says) which have the 
greatest value in use have often little or no value in exchange; which is true, 
since that which can be obtained without labour or sacrifice will command 
no price, however useful or needful it may be. But he proceeds to add, that 
things which have the greatest value in exchange, as a diamond, for example, 
may have little or no value in use. This is employing the word use, not in 
the sense which political economy is concerned with it, but in that other 


114 


THE EXPANSION OF ECONOMIC CONCEPTS 


sense in which use is opposed to pleasure. . . . The use of a thing, in political 
economy, means its capacity to satisfy a desire, or serve a purpose. Diamonds 
have this capacity in a high degree, and unless they did have it, would not 
bear any price.” ( Principles of Political Economy, Book III, Chapter I, 
Sec. 2.) 

These two quotations are given because they show what little advance 
was made in attempting to clarify the different aspects of utility, value in 
use, value in exchange, and price during the first seventy-five years of the 
history of economics. Each of these great authorities sensed that there was 
something wrong with the explanation given. Instead of clarifying the sub¬ 
ject, however, their attempts to straighten out the matter only served to 
make it more puzzling. 

After the lapse of another fifty years, and after much study had been 
made of the concepts which Smith, Ricardo, and Mill had dallied with we 
find in a modern text the following comment: 

"Until about fifty years ago, treatises on political economy regularly 
entered upon the discussion of values in exchange without having any special 
consideration to values in use, upon which they depend. As Adam Smith was 
largely responsible for this practice, it is worth while to recall how he came 
to fall into such a serious error. In his Wealth of Nations (Book I, Chapter 
IV) he defines values in use and values in exchange very much as we have 
done. Then after asserting that value in use is an essential condition of value 
in exchange, he goes on to prove that they have no further relation to each 
other by comparing the value of water with the value of a diamond. His 
exact words are: 'The things which have the greatest value in use have fre¬ 
quently little or no value in exchange; and on the contrary, those which 
have the greatest value in exchange frequently have little or no value in 
use. Nothing is more useful than water, but it will purchase scarce anything; 
scarce anything can be had in exchange for it. A diamond, on the contrary, 
has scarce any value in use, but a very great quantity of other goods may 
frequently be had in exchange for it’. The fallacy in this reasoning is obvious. 
The logical contrast is not between the value of water in general and a dia¬ 
mond, but between the value of a particular volume of water and a diamond. 
If Adam Smith had concentrated his attention on the value in use of a quart 
of water in the little Scotch village of Kirkcaldy, where he penned those 
sentences, he never would have asserted that the value of water was so 
great.” (Seager: Principles of Economics. Chapter VI, Section 61.) 

Between Mill and Seager are found many authors who have worked at 
the problem. Seager’s comment bears the impress of that fact. 

(2) The Cause of the Confusion. —Careful consideration of the defini¬ 
tions which were given a few pages back will make clear the fact that the 
confusion in Adam Smith’s mind and in the mind of his successors, was the 


CORRELATION OF VALUE AND PRICE 


115 


failure to distinguish utility from value in use. It should be remembered that 
utility signifies the quality of satisfying human desire, and that value means 
scarce utility. Regardless of the fact that the total utility of one good may 
be incalculably greater than that of another, if one exists in such large 
quantities that no particular amount of it is of any importance, it simply has 
no value. That is the case with air and possibly water. The case of diamonds 
is different. The total utility of diamonds is certainly far less than that of 
water or air. Yet the relation of supply to the number desired is such as to 
make every particular diamond of great importance to many people. The 
intensity of desire—marginal utility—of any particular one is registered at 
such a high point that it is conserved with extreme care. If lost it cannot be 
replaced except at great cost. Hence the marginal utility is high, as is true of 
its valtie in Jise, to those who desire it. Because of that fact the value in 
exchange is also very great. 

An analysis of the metaphysical aspects of the desire for diamonds might 
reveal surprising results. Just how much of the desire for them is dependent 
purely upon the fact that their value is high is hard to estimate. Regardless 
of that fact, as long as persons prize them for any cause the results are the 
same. Their marginal utility, value in use, value in exchange and price are 
very great. Exactly the reverse situation prevails with regard to air, water, 
and other free goods. Since their marginal utility is registered at zero—their 
value in use, value in exchange, and price remain at zero. Regardless of how 
many units of a thing one may have valued at zero the product will be zero. 

It may appear that the distinctions here made are somewhat labored. But 
it is so easy to fall into error regarding them that it is hardly possible to 
emphasize too strongly the basic points in their comprehension. 

Again it should be noted that it is incorrect to say that the value of the 
whole supply of diamonds is greater than the value of the whole supply of 
air or water. The value of the whole supply of air or water, considered as a 
unit, is far greater than the value of any other good. If it were possible for 
any one to gain control of that supply a value could be placed on it incalcu¬ 
lably great. It is this fact that makes it imperative that we clearly understand 
that a productive act is not that of creating value. Every productive act 
serves to reduce value. It makes goods and services more abundant, places 
them more and more into the position of free goods. The fact that economic 
goods can never be expected to become free through any productive process 
known to man does not alter the fact that acts of production have a 
tendency that way. 

(3) Circumstances of the Differentiation of the Concepts .—The effort 
of the mathematical economists (in the early ’70’s) to reduce all questions 
of value to matters of equilibria was the occasion of the differentiation of 
the concepts. In speaking of the work of the Mathematical Professor Alfred 


116 


THE EXPANSION OF ECONOMIC CONCEPTS 


Marshall has the following to say: “It is indeed doubtful whether much has 
been gained by the use of complex mathematical formulae. But the applica¬ 
tion of mathematical habits of thought has been of great service; for it has 
led people to refuse to consider a problem until they are quite sure what the 
problem is; and to insist on knowing what is, and what is not intended to be 
assumed before proceeding further.” ( Principles , Book III, Chapter I, Sec. 
20 

Be that as it may, it was in connection with the effort to treat every¬ 
thing in strictly mathematical terms that Stanley Jevons voiced the opinion 
that the expression ratio of exchange should be substituted for the term value. 
The work of Stanley Jevons bore fruit more in the direction indicated by 
Dr. Marshall than otherwise. Other authorities came to his assistance in 
working out the solution of the problem. Probably the honor belongs to 
Karl Menger of having given a better-balanced interpretation of the marginal 
utility theory of value than anyone else. Other names which are always men¬ 
tioned in this connection are Gossen, Walras, and Bohm-Bawerk. 

The originator of a new theory invariably has an exaggerated opinion of 
its importance. The work of the originators of the marginal utility theory of 
value should in no way be minimized merely because they thought that they 
had found a way to explain satisfactorily the whole phenomenon of values. 
Without the theory economics would be as confused today as it was in the 
time of J. S. Mill. Yet what the marginal utility theory really does is to give 
us a better starting point for the analysis of value. Instead of doing what 
Jevons suggested—making futile the search for the fundamental cause of 
value—it has opened the way for a more intelligent search for that cause 
(or the causes). 

It is just this that has happened between the appearance of J. S. Mill’s 
work and that of modern economic theorists. The thread of transition here 
alluded to is so evident in all authoritative works on economic theory that the 
task of showing how it came about is little, if anything, more than that of 
explaining the marginal utility theory of value itself. This takes form in the 
modern economic theory of prices. 


CHAPTER VII. 


PRICES 

Before proceeding with an explanation of the appearance of the marginal 
utility concept it is necessary to come to an understanding as to what price is, 

When Jevons spoke of the ratio of exchange as value he was really think¬ 
ing of price. Little else could be meant by the expression. It is, however, 
a rather broader concept of price than is usually given. It comes nearer ouf 
concept of market value than it does to price, although, as we shall see, 
it is not exactly synonymous with market value. The fact is, however, that 
in attempting to analyze the various aspects of value as thus defined, Jevons, 
and the other Mathematicals, did little more than give an intelligible inter¬ 
pretation of price. 

The definition of price as the ratio of exchange is hardly a satisfactory' 
basis of price analysis as practiced today. In this respect, as is true of a 
number of economic concepts, the science of economics suffers from a lack 
of consistent use of the same term. It will be necessary, therefore, for us to 
give at least two opposing definitions of price before we can proceed with out 
analysis. 

Definition of Price .—Closely related to the Jevens concept of price is 
Prof. F. A. Fetter’s definition as follows: tr Price is the good given by a buyer 
in a trade. In barter either good may be looked upon as the price of the 
other. 

"At present one of the two is most often money of some kind expressly 
mentioned or clearly implied. When money is used in a trade, its quantity 
is looked upon as the price, and the other good is looked upon as sold for, and 
bought with money. Price may be per piece of a conventional size, as per 
quart, bushel, yard, pound . . . The other good, that for which a price is 
paid, may be called the sale good” (Principles of Economics, p. 45.) 

Prices are more frequently thought of as not having existed before the 
invention of money. When this latter interpretation is put on price value in 
exchange is clearly differentiated from price. At first thought one might 
conclude that Professor Fetter’s definition of price would preclude this dis¬ 
tinction. But second thought will reveal the fact that even with the broad 
definition given to price by Fetter value in exchange would have to exist 


117 


118 


THE EXPANSION OF ECONOMIC CONCEPTS 


before the price phenomenon could come into play. Value in exchange and 
price would be coordinate only if actual trading occurred. Value in exchange 
would exist if persons were willing to trade. Price would exist only if 
trading actually occurred. 

The Fetter definition is not entirely at variance with the mathematical 
point of view. It is certainly not at variance with the marginal utility thesis. 
The following illustration from Gide and Rist will show this: 

"Imagine two Congoese merchants, the one, A, having a heap of salt, 
and the other, B, a heap of rice, which they are anxious to exchange. As yet 
the rate of exchange is undetermined, but let them begin. A takes a handful 
of salt and passes it to B, who does the same with rice, and so the process 
goes on. A casts his eye upon the two heaps as they begin mounting up, and 
as the heap of rice keeps growing the utility of each new handful that is 
added keeps diminishing because he will soon have enough to supply all his 
wants. It is otherwise with salt, each successive handful assuming an increas¬ 
ing utility. Now, seeing that the utility of the one keeps increasing, while 
that of the other decreases, there must come a time when they will both be 
equal. At that point A will stop. The rate of exchange will be determined, 
and the prices fixed by the relative measures of the two heaps. At that mo¬ 
ment the heap of rice acquired will not have for A a much greater utility than 
has the heap of salt with which he has parted. 

"But A is not the only individual concerned, and it is not at all probable 
that B will feel inclined to stop at the same moment as A; and if he had 
made up his mind to stop before A had been satisfied with the quantity of 
rice given him no exchange would have been possible. We must suppose, then, 
that each party to the exchange must be ready to go to some point beyond 
the limit which the other has fixed in petto. This point can only be arrived 
at by bargaining.’* (p. 524.) 

In a footnote the author adds: "We must be careful not to confuse 
matters, however. It is not suggested that the final utilities in the case of 
the two co-exchanges are equal. There is no common measure by which the 
desires of different persons can be compared, and no bridge from one to the 
other. What is implied is that the final utility of both commodities for the 
same person are the same. The balance lies between two preferences of the 
same individual. The actual market exchange is just the resultant of all these 
virtual exchanges.” 

The above quotation is given to show that Fetter’s definition of price lends 
itself to the marginal utility concept. But to make an exhaustive price 
analysis with that definition as a foundation might lead us into many com¬ 
plications. A more workable definition would seem to be the following: 
"To measure value, then, it is not enough to compare one value with another, 


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119 


as is done in barter; we must take the value of some one specific thing as a 
term of comparison. What is that thing? 

"The price of a thing is, then, the expression of the relation which exists 
between its value and the value of a certain weight of gold or silver, or 
more exactly, its value expressed in terms of money. And as in every civilized 
country, money is the sole measure of values used, the word price has come 
to be synonymous with the word value.” (Gide: Political Economy , p. 59.) 

In this study we shall follow Gide’s definition of price rather than that 
given by Fetter. With us, therefore, without money there is no price. Price 
is value in exchange quoted in terms of money. It usually takes the form of 
book value. 

Price Analysis. —There are two ways to approach the problem of price 
analysis. The one is explanatory and the other is descriptive. In the ex¬ 
planatory approach effort is made to discover the economic laws controlling 
the behavior of prices. In the descriptive approach the point of view is that 
of attempting to discover by use of statistics what have been the facts with 
regard to the behavior of prices. It is sometimes thought that the statistical 
method of approach is in conflict with the analytical method. In the very 
nature of things they cannot be anything but supplementary to each other. 
The economic laws controlling prices have already worked themselves out 
before the statistician can begin his study of the behavior of prices. Our 
problem here is to discover the nature of the operation of the laws which 
control price determination—those laws which have already had their fling 
before the descriptive study can even begin its approach. 

(1) Competitive Distinguished from Monopoly Prices. —The early 
economists were aware of the phenomenon of the monopoly price but they 
did not do a great deal with the refinement of the concept. With the de¬ 
velopment of the mathematical point of view monopoly price has received 
a great deal of attention. We have seen, however, that much study had 
already been made of the competitive price phenomena.. This has been already 
considered to some extent under the discussion of market value. 

In our explanation of the balancing of the demand schedule against the 
supply schedules in the determination of market value we called attention 
to the fact that the balancing process varied with different situations. It is 
only when there can be a full play of the forces at work on both supply 
and demand that we have established competitive prices. In a perfect market 
neither the buyers nor the sellers have the advantage. The one side is just 
as important as the other. A genuinely competitive price is, however, hard 
to find. When the buyers have the upper hand we have what is called the 
"sellers’ market.” The truly competitive market is neither a buyers’ nor a 
sellers’ market. 


120 


THE EXPANSION OF ECONOMIC CONCEPTS 


But a similar statement may be made about the monopoly price. A perfect 
monopoly price is almost as hard to find as a perfect competitive price. It 
would mean such a nice adjustment of the supply schedule to that of the 
demand schedule, or vice versa, that it is quite certainly as idealistic in its 
genuine form as the purely competitive price. Yet since the monopoly price 
is essentially a controlled price, whereas the competitive price is essentially 
not amenable to conscious control a clear differentiation should be made 
between them. 

(2) Monopoly Price Analyzed .—The fact that value grows out of 
scarcity whereas wealth is due to abundance is especially significant when 
one considers the nature of the monopoly price. The monopolist takes ad¬ 
vantage of the fact that scarcity makes goods valuable. In fact he controls 
their value and through that fact establishes a price to suit his purposes. 

The outstanding objective of business transactions is probably correctly 
assumed to be that of making the greatest gain afforded by the conditions 
of production and sale of goods. The monopoly price is based on that 
assumption. 

The monopoly-price phenomenon may appear either from the standpoint 
of the supply or from that of the demand. Since it most frequently makes 
its appearance on the supply side, that will be considered first. 

If the monopolist could know in advance exactly how many units of 
a commodity would be taken at the various possible prices the determination 
of the mononoply price would be comparatively simple. This would be par¬ 
ticularly true if he could also know in advance exactly how much the 
various amounts would cost him. Since he cannot know exactly either of 
these facts, it is hardly possible for him to set a price which would conform 
exactly to the law of monopoly price. His problem, however, is as best he can 
to set a price which will yield him the greatest return. Since not all goods 
have a cost of production it is not exactly correct to say that the monopoly 
price is arrived at by subtracting from the product, of the selling price and 
the number of units offered the cost of producing the units sold. Usually the 
monopoly price will be found that way, since most goods have a cost of 
production. The law of monopoly price, however, would just as certainly 
appear in connection with the sale of freely flowing mineral water marketed 
at the spring as it would in connection with goods produced and sold through 
positive injection into the channels of trade. 

Books are full of tables and graphs illustrative of the law of monopoly 
price. In most instances, however, they stop somewhat short of the true 
statement of that law. The following quotation from Gide’s Political Econ¬ 
omy states clearly and accurately the law of monopoly price: 

"Let us take the case, then, of the single seller, and, like Cournot, who 
first studied the law of prices under monopoly, let us take the owner of a 


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mineral spring which has unique healing virtues. We might think that, in 
this instance, it depends on the owner to fix any price he likes, and that 
consequently there is no law of prices at work. Nothing of the sort, however. 
Even under monopoly the fixing of prices is not arbitrary. It is still de¬ 
termined by demand, although no longer by supply. Let us suppose, to begin 
with, that an inexperienced monopolist tries the price of 10 francs a bottle; 
he will soon find that he is selling few bottles and making but little money— 
perhaps 1000 bottles, bringing in 10,000 francs. He therefore reduces the 
price to 1 franc and sells 100,000 bottles, making 100,000 francs; for he 
immediately finds a market among the great mass of the middle classes. 
Suppose that, encouraged by this, he reduces his price to 40 centimes a bottle. 
As the number of sick persons is limited, and mineral water is after all not 
taken for pleasure, he will sell only twice as much—200,000 bottles—and 
will be disagreeably surprised to find his receipts fall to 80,000 francs. He 
will hasten then to raise his price until he finds the price which, when multi¬ 
plied by the quantity sold, will give the maximum return; in this instance 
a franc a bottle.” ( Political Economy, p. 229.) 

An extension of the above problem is easily made when one includes 
the cost of production. The objective—that of maximum return—is the 
same. The problem, however, is somewhat more complicated when allowance 
has to be made for the varying costs of the different amounts taken. In 
this last instance the monopoly price is arrived at by finding the greatest 
return after deducting the expenses of production from the product of the 
selling price and the number of units sold. After making a list of the varying 
amounts that would be taken at the different prices and checking against 
each of these the cost of producing each amount the monopolist has simply 
to select the price which yields the largest net return. The student will do 
well to construct one or more tables involving the calculation of the law 
of monopoly price in order to fix it in his mind. 

Skillful monopolists are not always satisfied merely with realizing the 
gains of the law of monopoly price. They resort to measures to make in¬ 
roads into the consumers’ surpluses. By clever classification articles which 
are in fact no better than the basic ones may be sold to the fastidious by 
means of appealing to their false pride. The phenomenon is often observed 
at circuses and other public entertainments when persons are induced to 
purchase "reserved seats” simply because they are "reserved” seats. It might 
not be possible for the monopolist to draw off all of the consumers’ surplus 
by thus appealing to the false pride of buyers but certainly a substantial 
increase in his profits can be made by skillful merchandising. The phenomenon 
has been well dubbed "class price.” 

It may be asked what has all of this to do with marginal utility? The 
answer is very evident. The monopolist so controls his offerings that the 


122 


THE EXPANSION OF ECONOMIC CONCEPTS 


intensity of desire will be registered at a higher point than would be ex¬ 
pected under a condition of free competition. If other sellers could appear 
the price might be pressed down far below that established by the monopolist. 
The price established under a condition of monopoly is just as certainly in 
conformity with the principle of marginal utility as is true under economic 
freedom. In some instances the monopolist realizes that the price which would 
take all of a large output would not bring as great a return as would the 
price of a small amount. Goods, therefore, the supply of which he cannot 
readily control are not infrequently destroyed for no other purpose than that 
of keeping the price up. At this point we have an interesting conflict be¬ 
tween individual and social interest, the one growing out of value and the 
other out of wealth. 

Something might be gained by making a classification of monopolies. It 
is doubtful, however, that the results would be worth the effort. All 
monopolists resort to similar tactics. In those monopolies which control im¬ 
portant public services it becomes necessary for the government to establish 
boards of control so as to prevent the monopolists from sacrificing the 
interest of the public to their own interest. These public commissions are 
just as much at the mercy of the law of monopoly price as are the monopolists 
themselves. We have already alluded to this in connection with our study 
of normal value. 

Thus far we have considered the monopoly phenomenon from the side 
of the producer, or seller. There might just as well be monopoly from the 
standpoint of the purchaser. The five great meat packers are said to divide 
the territory from which they secure their live-stock, in such a way as not 
to compete with one another. If that is true—and there is evidence that the 
accusation has foundation in fact—the sellers of live-stock are almost en¬ 
tirely at the mercy of the buyers with regard to the price which they must 
accept for their animals. 

The law of monopoly price, when the price is set by the buyer, presents 
a different aspect from that set by the seller. In the long run it cannot be 
less .than the expenses of production of the producer whose supply is needed 
along with those who produce more cheaply in order to satisfy the market. 
In this instance the satisfaction of the market is simply supplying the needs 
of the buyer. The price would have to be at least that much or the animals 
would not be sent to the market. If the monopolist is a keen buyer his price 
would not for any great length of time remain above that point. That would 
be the expenses of production of the marginal sellers. 

The monopolist could for a time force the price below the expenses of 
production of the marginal producers. This could be done by boosting the 
price arbitrarily for the purpose of drawing into the market inordinate ship- 


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123 


merits of animals. Thereupon the price might be forced down to a very 
low level. 

The sellers might protect themselves from a buyer of this kind by means 
of an effective cooperative selling agency. If the sellers could organize and 
sell as a unit instead of as individuals then the power of the monopolist 
buyer would be broken. This action would bring into play the one-buyer-one- 
seller price phenomenon. Any price that might be set would certainly be 
more favorable to the sellers than if they remained at the mercy of the 
monopolist buyer. 

(3) The Competitive Price. —The above discussion shows that from any 
point of view the monopoly price is a controlled price. The competitive price 
is in the very nature of the case anything but a controlled price. By assump¬ 
tion it is not amenable to positive control. 

The supply and demand schedules which have been explained in con¬ 
nection with market value really make themselves felt through prices. A 
study of the balancing of the supply and demand schedules in the determina¬ 
tion of market value is also applicable to the balancing of the supply and 
demand schedules in the determination of market prices. Considerable atten¬ 
tion has already been given to this point in Chapter IV. 

If prices and values could be made to conform or vary together there 
would be little if any need to study the phenomenon of competitive prices 
as distinct from market value. Since they do not conform nor vary together 
it becomes necessary to study prices as distinct from value. 

Before proceeding with special attention to those points where prices 
vary from values it will be helpful to develop somewhat more clearly the 
law of competitive prices as it has been worked out by the neo-classical 
economists. 

One of the most useful contributions made by the neo-classical economists 
was the demonstration that the competitive price is an exact price. It is 
just as certainly a single price as is the monopoly price. 

The fact that on the competitive market there are many buyers and 
many sellers might lead to a hasty assumption that goods of the same kind 
and quality would be available at different prices. The demonstration of the 
fact that such a contingency could not logically prevail was proved by 
the deductive method of the mathematical economists. Their proof of this 
has well been presented by Prof. Gide in, the following language: 

"Value in exchange is called price. Value and price are not, however, 
the same thing, since price is, as we say, only one of the thousand possible 
expressions of value. Value is a relation established between any two things; 
price is a relation in which one of the two terms is always money. It need 
not necessarily be coined metal or paper money; for in Africa, where pieces 
of cotton, or glass beads are used as money, the value of goods thus expressed 


124 


THE EXPANSION OF ECONOMIC CONCEPTS 


is also their price. But the word price implies a common measure, a standard 
.of comparison . . . 

"Let us look, then, at the conditions which exchange value, or current 
price, must fulfill: 

"They may be put as follows: 

" (1) There can be only one price on the same market at a given moment 
for similar products. This is what Jevons called the law of indifference , 
meaning that, whenever two or more objects are identical, so that it is a 
matter of indifference to us which we choose, i. e., whenever we have no 
motive for preferring one to the other, we will not pay more for one than 
for the other. 

"We might at first think the contrary. Suppose, for example, that on a 
given market, there are ten wheat sellers, each seller wanting a different price 
for his sack of wheat. Suppose, on the other hand, there are ten buyers, each 
attributing a different value to the wheat which he wants to buy. Why 
should there not be as many different prices as there are pairs of exchangers, 
the buyer who is prepared to pay most coming to an agreement with the 
most exacting seller, while the buyer least pressed by necessity arranges with 
the least exacting seller for a much lower price? The reason is that no buyer, 
however great his desire to buy, will consent to give a higher price than the 
rest are giving; and that no seller, however easy going, will consent to give 
his wheat for a lower price than his fellows. Both, therefore, wait until the 
market price is fixed. 

"It is this unique market price, at a given moment, that is called the 
.current price. This current price is quoted in special newspapers for all 
the most important goods—wheat, wines, coal, cotton, wool, copper, etc.,— 
as well for movable values and government stock, and serves as basis for 
commercial operations. 

"(2) This one price must be such as to cause the quantity offered and 
the quantity demanded to coincide. 

"The two quantities are absolutely bound to coincide: it is absurd and 
contradictory to suppose that more sacks of wheat can be sold than are 
bought, since they are one and the same sacks. 

"But this coincidence does not come about immediately. It is only after 
a series of oscillations between quantities offered and quantities demanded, 
corresponding to oscillations in price, that equilibrium is established and 
current price appears. Take, for instance, our ten wheat sellers who are 
offering their sacks of wheat to ten buyers, but are asking 22 francs each 
for them. Some of the buyers, finding the price too high, withdraw, and 
only five, say, remain. The ten sellers, foreseeing that their wheat will be 
left on their hands, undersell each other in order to obtain the preference 
*of the five buyers, and come down to 20 francs. This price brings back three 


PRICES 


125 


of the buyers who had left, and there are now eight buyers ready to take 
eight sacks. If the ten sellers are determined to sell at any cost, they must 
resign themselves to reducing their price still further, say to 18 francs, in 
order to bring back the two most timid buyers and make demand rise to the 
level of supply, i. e., to ten sacks. But two of the sellers may possibly prefer 
to take away their sacks rather than go below 20 francs. In this case 20 
francs will remain the market price, for at this price there are eight sacks 
sold and eight sacks bought. Each demand finds its counterpart and the 
necessary coincidence is realized. 

" (3) The market price must be such as to give satisfaction to the greatest 
possible number of pairs of buyers and sellers present on the market. 

"To illustrate this let us put buyers and sellers over against one another 
on the wheat market, and express their claims in order, on descending scale, 
beginning with the seller who asks the highest price and coming down to 
the one who is content with the lowest, and the buyer who offers the least 
down to the one who is content to pay the most. 


5 1 asks 22 francs 

5 2 asks 21 francs 

5 3 asks 20 francs 

5 4 asks 19 francs 

5 5 asks 18 francs 


B 1 offers 18 francs 
B 2 offers 19 francs 
B 3 offers 20 francs 
B 4 offers 21 francs 
B 5 offers 22 francs 


"Suppose S 1 opens fire by asking 22 francs. At that price there will be 
only one buyer, B 5 , inclined to close with him, since none of the others is pre¬ 
pared to give the price asked. At this price, therefore, only one bargain would 
be made and only one sack sold. But B 5 will not be so simple as to give 22 
francs, the maximum price, if he can get wheat for less. He will wait, 
therefore, until other less exacting sellers have stated their prices. Then comes 
S 2 , who asks only 21 francs. This demand brings forward a second buyer, B 4 . 
There are now two buyers ready to come to terms, but on the other hand, 
there are three buyers who will not go so high. 

"Lastly comes S 3 , who asks only 20 francs. Three buyers out of five, that 
is to say, the majority, are disposed to close with this price, and, as there 
are exactly three sellers ready to accept it* there will therefore be three 
couples satisfied out of five. No other price would give the same result. 
This is the price, therefore, which will be the law of the market. For, if we 
suppose for a moment that S 4 were to consent to sell at 19 francs, there 
would no doubt be four buyers content with this price, but the three first 
sellers would refuse to sell and would withdraw. There would remain there¬ 
fore only two sellers as opposed to four buyers. And the buyers who could 
get served at 19 francs would hasten to recall the sellers who were on the 
point of starting off to look for better prices. 


126 


THE EXPANSION OF ECONOMIC CONCEPTS 


"As for S 1 and S 2 on the one hand, and B 1 and B 2 on the other, if they 
will not compromise they will simply leave the market and will take no 
part in fixing the price.” ( Political Economy , pp. 222-22 5.) 

Gide has been quoted at some length for in the opinion of the author 
he has presented the concept in a most illuminating manner. The exponents 
of the marginal utility theory of price determinations are not satisfied merely 
with arithmetical illustrations but they take hypothetical cases, such as this 
given by Prof. Gide and reduce them to graph. On the basis of an imaginary 
collection of data the demand curve is constructed in such a way as to 
intersect the supply curve. The demand curve of course descends toward the 
right and the supply curve ascends to the right. The point of intersection 
must of necessity be the price which accommodates the maximum number 
of buyers and sellers—the point at which the amount offered and amount 
demanded are equal. 

It is probably a worth-while exercise for the student to construct a few 
of these curves for the purpose of fixing the law of supply and demand in 
his mind. There is, however, danger that the student by that procedure will 
obtain an erroneous notion of the behavior of the law of supply and demand. 
Since accurate data for the construction of supply and demand schedules are 
not available for particular commodities the student is likely to fill his 
mind with imaginary facts that are too far from actuality. At any rate 
the use of graphs to represent prices in their analytical aspects should be 
made with caution. No such assumption is made with regard to the employ¬ 
ment of graphs to show price trends. Here we have a useful statistical device 
that is very helpful. Price trends, however, begin where the theory of 
prices ends. 

Evidently the marginal utility theory of prices is not entirely satis¬ 
factory. Owing to the fact that it does not make possible forecasts—at least 
not very accurate forecasts—the theory has not received universal acceptance. 
It has, nevertheless, received wide acclaim. It would be well nigh impossible 
to find a standard text on economics today that does not present the marginal 
utility theory of price determination as the last word on the subject. 

Before proceeding with the more detailed analysis of price let us take 
a look at the criticism of the marginal utility theory. 

The Marginal Utility Theory Criticised. —The following quotation from 
Gustav Cassel is given at length because in the opinion of the author Dr. 
Gassel is one of the most brilliant of the contemporary economists. As is 
evident in the quotation, Dr. Cassel sees very little of significance in the 
marginality utility thesis: 

"This purely formal theory, which in no sense enlarges our knowledge 
of the real processes, is in any case superfluous as far as the problem of 
prices is concerned. 


PRICES 


127 


“We must further observe that this deductive inference of the nature 
of demand from a single principle, in which so much childish pleasure has 
been taken, was impossible without artificial construction and considerable 
distortion of the reality. 

“First, an abstract estimate, expressed in any scale of reckoning what¬ 
ever, of the utility of the various stages of the satisfaction of wants in all 
of its branches is not possible for the economic man. For such estimates he 
needs at least the support of the existing prices, and the most that he can 
do is to calculate with some probability the change of his demand that would 
be caused by the alteration of one price. His whole scale of reckoning is 
necessarily bound up with the actual prices. If we keep strictly to the simple 
facts, we can only say that men decide what they will buy when all prices 
are given: decide, that is to say, upon the line to be drawn between those 
wants which will satisfy and those which they will ignore. Further than 
that, as we said, economic science need not concern itself. 

“Further, the principle that the marginal utility is equal to the price 
is by no means sound. Even when a want can be satisfied in successive doses, 
it is not at all certain that the last dose of satisfaction is equal in value to 
the price. As far as the wants which are fully satisfied are concerned it is, 
on the contrary, the rule that even the utility of the last dose is appreciated 
beyond its price; which is plain from the fact that those wants are satisfied 
even if the price is a little higher—in other words, that its elasticity is equal 
to nil. Moreover, the various stages of satisfaction of wants do not always 
run in the continuous series which the theory assumes. A tenant who rents 
a house at £100 will, as experience has often shown, keep the house even 
if the price is raised to £110. Here the marginal utility is higher than the 
price. Yet the tenant will not take a larger or better house, because one to 
suit him might, perhaps have a rent of £120. Hence the solution of the 
problem of equal satisfaction of wants on the part of the individual as it 
is usually formulated in terms of the theory of marginal utility is not 
correct. If we are to speak at all of an estimate of the value of wants, we 
must be content with something like the following principle: On the existing 
prices every want that is considered of less value than the price of satisfying 
it does not get satisfaction, and the other wants, which are least held to be 
worth the price, are satisfied.” (Social Economy , p. 81.) 

Stated briefly Cassel’s attack on the marginal utility thesis amounts to 
saying that it is prices that determine marginal utility instead of marginal 
utility that determines prices. An explanation which depends on the phenome¬ 
non which it is to explain cannot be an explanation. It amounts to circular 
reasoning. 

In seizing on an accusation of that kind Professor Cassel is striking at 
the Achilles’ heel of economic philosophy. Reasoning of that kind has proven 


128 


THE EXPANSION OF ECONOMIC CONCEPTS 


to be the most frequent error of students of economic theory. But let us 
examine the question further. 

Early in this chapter we showed that marginal utility is not dependent 
on price. That is certainly true if we define price as value in exchange 
quoted in terms of money. If the reader will recall our illustration of the two 
merchants trading rice for salt it will be evident that marginal utility is 
just as certainly present in connection with barter as it is with price. It is 
more easily determined when the phenomenon of price makes its appearance. 
The force, however, was most certainly operative in human affairs long before 
mankind hit on the device of employing money to facilitate trading. 

We have seen further that prices are values in exchange quoted in terms 
of money. But money itself has value. If the marginal utility thesis will 
satisfactorily explain the value of money it would seem that the marginal 
utility thesis will satisfactorily explain prices. 

Since the social value of money must be distinguished from its individual 
value, unless we proceed with caution, we are likely to run into con¬ 
tradictions. 

The social value of money is constant, i. e., the value of money and prices 
vary inversely. From this it might appear that marginal utility has no in¬ 
fluence whatever on money. 

But individually the marginal utility phenomenon appears in connection 
with money as certainly as it does with any other good. 

Furthermore, individual value of money controls its social value. 

Since prices are the resultant of the social value of money, we must 
conclude, from this, that marginal utility explains prices. 

The above propositions must each be proved for the conclusion to be a 
logical deduction. With regard to most of these we shall let the exponents 
of the marginal utility thesis speak for themselves. 

(1) The Constancy of the Value of Money .—Economists are not in full 
accord with regard to why it is that the value of money and prices vary 
inversely. The view of the mathematical economists is decidedly that the 
cause is to be found in the quantity of money in circulation. If the quantity 
increases for any reason the value of money declines and prices rise, and 
vice versa. The older early classical economists—particularly Ricardo— 
stated the law with mathematical exactitude. That meant that the change 
in prices would follow in exact ratio to the change in the amount of money. 
The neo-classicals, however, being faced with too many actual denials of 
the mathematical exactitude of the relation between the quantity of money 
and prices as a whole have departed somewhat from the point of view ad¬ 
vanced by Ricardo. They still hold to the quantity theory of money but 


PRICES 


129 


assert that other influences must be taken into account than that of mere 
quantity. But a small amount of money has the same social value as a large 
amount. 

(2) The Marginal Utility of Money .—The control of the marginal utility 
over the value of money would be easily seen if the quantity theory of money 
were unquestionable. This would simply mean that with each increase in 
amount, in obedience to the law of diminishing utility, the value of money 
would decline. Since marginal utility simply means the intensity of desire 
for any given amount of a commodity at any given time, the value of money 
would be measured by its marginal utility. If it became so abundant as to 
be valueless its marginal utility would be registered at zero. 

Yet, even if the quantity theory of money be not accepted there must 
be a logical correlation between the individual and social function of money. 
This leads us into the explanation of the marginal utility of money in the 
light of the desire on the part of individuals for money. The following quota¬ 
tion from Prof. Alfred Marshall states in a most convincing way the marginal 
utility of money from the standpoint of the individual: 

"The larger the amount of a thing that a person has, the less, other 
things being equal (i. e., the purchasing power of money, and the amount 
of money at his command being equal), will be the price which he will 
pay for a little more of it; or in other words his marginal-demand price 
diminishes. 

"His demand becomes efficient , only when the price which he is willing 
to offer reaches that at which others are willing to sell. 

"This last sentence reminds us that we have as yet taken no account of 
changes in marginal utility of money, or general purchasing power. At one 
and the same time, a person’s material resources being unchanged, the 
marginal utility of money to him is a fixed quantity, so that the prices he 
is just willing to pay for two commodities are to one another in the same 
ratio as the utility of those two commodities. 

"A greater utility will be required to induce him to buy a thing if he is 
poor than if he is rich. We have seen how the clerk with £100 a year will 
walk to business in a heavier rain than the clerk with £300 a year. But 
although the utility, or benefit, that is measured in the poorer man’s mind 
by twopence is greater than that measured by it in the richer man’s mind; 
yet if the richer man rides a hundred times in the year and the poorer man 
twenty times, then the utility of the hundredth ride which the richer man 
is just induced to take is measured to him by twopence; and the utility of 
the twentieth ride which the poorer man is only just induced to take is 
measured by him by twopence. For each of them the marginal utility is 
measured by twopence; but the marginal utility is greater in the case of 
the poorer man than that of the richer.” (Principles of Economics , p. 95.) 


130 


THE EXPANSION OF ECONOMIC CONCEPTS 


(3) Now finally we must demonstrate that the individual value of money 
controls its social value. Professor Seager has fortunately made this demon¬ 
stration for us in the following language: 

"Increasing the supply of any good, other things remaining the same, 
causes a fall in its price. If the increase is so great that the good becomes 
superabundant, its price will be reduced to nothing and it will be free. As 
regards any single branch of production, it is, therefore, clear that increas¬ 
ing the net product itstead of adding to the resulting money income, may, 
if persisted in, wipe it out altogether. Can the same be true of an increase 
in the net product of collective national industries? A little thought as 
to the reasons for the decline in the price of any single good as its supply 
increases will convince the reader that it cannot. Exchange values and prices 
are relations among goods. Increase the supply of one and the ratio at which 
it exchanges for other goods or money will change to its disadvantage. If, 
however, you increase at the same time the supplies of all goods, including 
gold, the standard money material, you affect simultaneously both sides of 
all ratios of exchanges and consequently the ratios remain as before. Values 
in use, measured by marginal utilities may be lowered, that is, the community 
may have its wants for all kinds of goods more amply gratified. Values in 
exchange and prices will not be affected, since the increase of the net product 
is a general increase embracing all the different products of collective national 
industries. This conclusion may be accepted the more confidently, since for 
obvious reasons the tendency of competition is always to direct the factors 
of production into those industries in which prices are rising or remaining 
constant and away from those in which they are falling, or, if conditions 
are such that prices generally show a downward trend, then into gold mining 
until the increased supplies of the standard money material restore the bal¬ 
ance.” (Principles of Economics, pp. 177-8.) 

Marginal utility, therefore, working through commodities and ultimately 
through money, dominates the value of money and prices. We must conclude, 
therefore, that the individual value of money controls its social value. From 
this we conclude that marginal utility explains prices. 

We should always be careful, however, not to say determines prices. As 
Professor Marshall carefully points, all demand and supply influences affect 
the prices. The marginal influence is only the indicator. It is there that 
we go to find the causes which are at work in determining prices. 

The other points made by Dr. Cassel are not lost sight of by the ex¬ 
ponents of the marginal utility thesis. Take for instance the allusion to 
marginal utility being applicable only in cases where commodities can be 
had in series; that it does not explain satisfactorily a thing like house rent. 
The following answer to that point will be borne out by persons who have 
had experience with rent property. Money payments do not represent all of 


PRICES 


131 


the rentals. There may be occasions when money payments may measure 
very closely the marginal utility of the house in which a family happens to 
live. But in periods of rising or falling rents—even though the tenant may 
be operating under lease—other methods of adjustment than money pay¬ 
ments come into play. Certain improvements that the tenant might be willing 
to make at his own expense if he were conscious of the fact of paying 
less than the commercial rate would not be made if he felt that the money 
payments were as great as or greater than the marginal utility of the 
services of the house occupied. 

The fact that the landlord might be able to raise the rent from £100 
to £110 a year without losing the tenant could easily be accounted for in 
those supplementary adjustments. 

But even the exponents of the marginal utility thesis do not defend it as 
entirely satisfactory. It is presented as the best that can be done with the 
complicated subject-matter with which they are dealing. For instance 
Marshall writes as follows: 

"It cannot be too much insisted that to measure directly, or per se, either 
desires or the satisfaction which results from their fulfillment is impossible, 
if not inconceivable. If we could, we should have two accounts to make 
up, one of desires, and the other of realized satisfactions. And the two might 
differ considerably. For, to say nothing of higher aspirations, some of those 
desires with which economics is chiefly concerned, and especially those con¬ 
nected with emulation, are impulsive; many result from force of habit; 
some are morbid and lead only to hurt; and many are based on expectations 
that are never fulfilled. . . . The two direct measurements then might differ. 
But as neither of them is possible, we fall back on the measurement which 
economics supplies, of the motive or moving force to action: and we make 
it serve, with all its faults, both for the desires which prompt activities 
and for the satisfactions that result from them.” (Footnote pp. 92-3, 
Principles of Economics.) 

Probably no better conclusion concerning this whole matter can be found 
than the following language of Gide and Rist: 

"An easier line of criticism, and one very frequently adopted, is to main¬ 
tain that wants and desires of mankind are incapable of measurement and 
that mathematical causations can never be reconciled with the doctrine of 
free will. But such claims as these were never put forward by the Mathe¬ 
matical school. On the contrary, it has always recognized that every man 
is free to follow his own bent . . . merely inquiring how man is to act 
if he is to obtain the maximum satisfaction out of the means at his disposal 
and to overcome the obstacles that stand in his way. Neither has it ever 
ventured to say that such and such a man is forced to sell corn or to buy it, 
but simply that if he does buy or sell it will be with a determination to 


132 


THE EXPANSION OF ECONOMIC CONCEPTS 


make the best of the bargain, and that such being the case the buying or 
selling will take place in such and such a fashion. It further claims that the 
action of a number of individuals under similar circumstances is equally cal¬ 
culable. So is the movement of the balls on the billiard-table, but that does 
not interfere with the liberty of the players. 

"Nor do they pretend to be able to measure our desires. What they do— 
and that is not so absurd after all, because we are all doing it—is to express 
in pounds, shillings, and pence the value we put upon the acquisition or 
loss of an object that satisfies our desire. Moreover, the Mathematical school 
does not make much use of numbers, but confines itself to algebraical nota¬ 
tions and geometrical figures—that is, to the consideration of abstract 
quantities. To write down a problem in the form of a mathematical equation 
is to show that the problem can be solved and to give the conditions under 
which solution is alone possible. Beyond this the economist never goes. He 
never tries to fix the price of corn, whatever it may be; he leaves that to 
the speculators.” (History of Economic Doctrines, p. 53 8.) 

Any further discussion of criticisms of the marginal utility thesis would 
take us into attacks on the automatic system of production and distribution. 
That would take us into the whole problem of the practicability of a con¬ 
scious plan of control of production and consumption, a problem which is 
beyond this particular study. 


\ 



Karl Robertus ( 1805 - 1875 ) 


In the person of Rodbertus we find one of the very few socialists who show an approxi¬ 
mation to the comprehension of the bearing of economic laws on business procedure. So certainly 
is that true that hardly any basis exists for difference of opinion regarding his criticisms of 
the way things tend actually to go in the business world. Then, further, even though we cannot 
accept his conclusions as to what should be done, we are forced to grant that whenever the 
government has actually attempted to set up a plan of conscious control in lieu of the auto¬ 
matic system it has been done along lines suggested by Rodbertus. That is true whether or not 
the assumption that Marxian socialism is being instituted or a less ambitious scheme is being 
tried. 


133 





134 


THE EXPANSION OF ECONOMIC CONCEPTS 


We have chosen to place Rodbertus at this point in our study because of his challenge to 
the consideration of the real part which the government should take in the direction of business 
ventures. The cry for governmental help is insistent. To say that the government should do 
nothing is to accept laissez faire. To say that it should do everything is to accept socialism. 
Modern economic philosophy does not accept either. In the following chapter we have suggested 
that a study of the way that economic laws operate with regard to certain specific commodities 
might become a basis as to certain things that the government could do effectively and bene- 
ficiently. These things, however, are the things that the government is apparently least likely 
to attempt. 

“It is hardly correct to speak of production adapting itself to social needs under existing 
conditions, because production only adapts itself to the effective demand, i. e. to the demand 
when expressed in terms of money. This fact had been hinted at by Smith, and Sismondi had 
laid considerable stress upon it; but Rodbertus was the earliest to point out that this really 
meant that only those people who already possess something can have their wants astisfied. 
Those who have nothing to offer except their labour, and find that there is no demand for 
that labour, have no share in the social product. On the other hand, the individual who draws 
an income, even though he never did any work for it, is able to make effective his demand for 
the objects of his desire. The result is that many of the more necessitous persons must needs go 
unsatisfied, while others wallow in luxury.”—Gide and Rist: History of Economic Doctrines, 
p. 419. 

“Rodbertus* upbringing decreed that he should not become involved in that democratic 
and radical socialism which was begotten of popular agitation, and whose best-known repre¬ 
sentative is Marx. Marx considered socialism and revolution, economic theory and political 
action, as being indissolubly one. Rodbertus, on the other hand, was a great liberal landowner 
who sat on the Left Center in the Prussian National Assembly of 1848, and his political faith 
is summed up in the two phrases 'constitutional government* and 'national unity.’ The success 
of the Bismarckian policy gradually drew him nearer the monarchy, especially toward the end 
of his life. His ideal was a socialist party renouncing all political action and confining its atten¬ 
tion solely to social questions.” (Ibid. pp. 416-7). 

“His intellectual horizon—largely determined for him by his knowledge of . . . French 
sources—was fixed as early as 1837, when he produced his Forderungen, which the Gazette 
Universelle d’ Augsburg refused to publish. His first work appeared in 1842, and the earliest 
of the Social Briefs belongs to 18 50 and 1851.”— Ibid, p. 415. 


CHAPTER VIII. 


BUSINESS MEN’S REACTIONS TO THE LAW OF 
COMPETITIVE PRICE 

When a business man cannot benefit by the magic of the law of 
monopoly price, he has to operate at the mercy of the law of competitive 
price. One of the most difficult experiences of the business man is to resign 
himself to the fate of being at the mercy of that law. Unless the commodity 
which he has to offer is of such a nature as to be amenable to monopoly, 
regardless of anything that the business man may do he must in the end 
submit to the power of competition. This is nothing more than saying that 
the business man has to keep pace with economic progress or in the end 
be ground under its wheel. The various reactions to the automatic laws 
of competition are the concern of the present discussion. 

Different commodities have different ways of finding their adjustment 
to the market. Some adapt themselves to the organized exchanges. Others 
adapt themselves to cooperative marketing agencies; some are better offered 
through advertising media, and some have difficulty in finding a market 
in any way. The business man’s reaction to the laws of competition has to be 
studied in relation to which of these types of commodities is the concern of 
his particular enterprise. We shall study each of the types separately. 

The Organized Exchanges. —The place where the law of supply and 
demand works itself out most perfectly is in the organized exchanges. These 
divide into two classes, i. e., those handling commodities and those which 
handle stocks and bonds. 

Not all commodities adapt themselves readily to the organized exchanges. 
As a general rule paper (or securities), is better adapted than goods 
themselves. In fact there are only a relatively few commodities that are 
adapted to future transactions. Since one of the outstanding characteristics 
of the organized exchange is dealing in futures, commodities not thus adapted 
are not fitted for exchange transactions. The essential conditions are: 

**(1) That it (a commodity) be not quickly perishable; (2) that the 
quantity of each thing can be expressed by number, weight or measures; 
(3) that its quality can be determined by tests that yield almost identical 
results when applied by different officials, assumed to be expert and honest; 


135 


136 


THE EXPANSION OF ECONOMIC CONCEPTS 


and (4) that the class is important enough to occupy large bodies of 
buyers and sellers. 

‘'These conditions are sufficient to render organized marketing prac¬ 
ticable. But a fifth condition is required to make it attractive; it is that 
the class of things dealt in should generally be liable to considerable fluctua¬ 
tions in price.” (Marshall, Indutsry and Trade, p. 256.) 

A little reflection will show why it is that those five conditions are 
essential to organized exchanges. With the first four the exchanges could 
exist, but there would be no futures market. It is doubtful that privately 
organized exchanges would thrive without the futures market. We may 
safely say, therefore, that there are five essential conditions attached to com¬ 
modities which find their market through the organized exchanges. 

When we reflect upon the relatively few commodities which possess 
all five of these characteristics it is not surprising that so few goods have 
a ready and established market. The commodities which possess the qualities 
are: the grains, "sugar, coffee, and cotton—the leading agricultural com¬ 
modities. Organized exchanges for stocks and bonds are, of course, matters 
of common knowledge. Spasmodic efforts have been made to organize ex¬ 
changes for certain other goods but only with a modicum of success. Wool, 
for instance, would appear to possess the necessary qualifications. But efforts 
at the establishment of wool exchanges have invariably failed because of the 
absence of one or more of the conditions indicated. Wool does not lend 
itself readily to standardization nor does it command the interest of enough 
buyers and sellers necessary to the exchange. 

An insight into the inner workings of one of the exchanges will be highly 
illuminating. The following is taken from a pamphlet published by the 
Chicago Board of Trade. The descriptions here given may be taken as typical 
of any of the organized exchanges. 


REACTIONS TO LAW OF COMPETITIVE PRICES 


137 



A View from the Gallery 

THE CHICAGO BOARD OF TRADE—WHAT IT MEANS 

“This is the place where the rise and fall of grain prices responsive to the great law of 
.supply and demand is registered minute by minute, hour by hour, and day by day while the 
Chicago Board of Trade is in session. 

“Buying and selling grain is the occupation of the busy men who crowd the floor of the 
exchange. The traders can be roughly divided into two groups. Those on the left, standing or 
walking among the rows of marble topped tables are the cash grain dealers. 

"They bargain for car loads of grain, samples of which in small paper bags, are before 
them on the tables. The samples, small quantities of grain from each car load, have been taken 
from cars of grain in the railroad switching yards around the city. Many of the cars arrive 
in the yards the very day the grain is sold on the Exchange. 

"The grain has been tested by the Illinois State Grain Inspectors and the Sampling Depart¬ 
ment of the Board of Trade, and each bag shows the official grade of its contents according to 
the standard fixed for the entire country by Federal enactment. 

“The buyers, men who know grain as few men can, sift the grain between their fingers, 
perhaps smell of it or split a kernel open before making an offer. The sellers are quite as acute 
and lose no opportunity of disposing of their car lots. 

“There is some confusion around the cash tables as the buyers move from sample to sample, 
and offers and demands are accepted or rejected, but the hubbub is as nothing to the noise and 
excitement near by where other groups of grain buyers and sellers are equally but more noisily 
busy. 

“These men deal in specified grades of grain which have been established by the State and 
Federal regulations. The unit of trading is the bushel and the trading is in contracts for delivery 
at a future date. In other words, one trader buys and another sells a contract calling for the 
delivery of a specified number of bushels of grain of a standard quality in a certain month. 

“If the contract calls for delivery in December it is referred to as December wheat, corn, 
oats or other grain as the case may be. If the contract specifies May for delivery it is a trade 
in May grain. These contracts are called futures, and the future takes its name from the 
delivery month, not the harvest or the month in which the sale is made. 
























138 


THE EXPANSION OF ECONOMIC CONCEPTS 



The Cash Tables 


Traders in futures or contracts for future delivery occupy what are known as the pits, 
each of which is a series of steps raised in circular form leaving a pit-like depression in the 
center from which the name is derived. Their peculiar form enables traders standing on the 
different levels to see each other clearly and so transact business in spite of the tumult. 

"There are five pits. One for each of the major grains, wheat, corn, and oats. One for 
provisions, and one, the smallest on the floor, for rye and barley. The method of trading is 
the same in each pit. 

"Confusion worse confounded is the impression on seeing the exchange at close range, and 
hearing the roar of many voices, swelling and diminishing like a great organ playing a tune¬ 
less melody. 

"But intelligent men are not given to meaningless madness, and it would be difficult to 
find a more intelligent group than that same shouting, hand-waving crowd. 

The key to unlock order out of the seeming confusion is the sign 
language, the old, cld motion talk which scientists tell us preceded the 
earliest speech, and which has here been revived, brought under strict rules 
and carried to its highest expression. 

"The telegraph, the telephone, the airplane, the locomotive, and every 
other human contrivance to hasten business gives precedence to the simple 
gesture of the hand as the ultimate of rapidity in business transactions in 
the grain pits of the Exchange. 

"The sign language is simple and consists of eight motions covering 
fractional changes in price, and a ready code, denoting the amount of 
bushels bought or sold. 

Prices are denoted by the hand held horizontally. Held vertically the 
nand signals the quantity desired or offered. The hand signaling price or 
quantity held with the palm out or away from the trader, shows a desire 
to sell, with the palm toward the trader it denotes a wish to buy. 

The horizontal clenched fist denotes an even price, say $1.80 a bushel. 

One finger extended, one-eighth of a cent; two fingers spread apart, one- PRICE CODE 
















REACTIONS TO LAW OF COMPETITIVE PRICES 


13 ? 



The Tit 


fourth of a cent; three fingers spread apart, three-eights of a cent; four fingers spread apart, 
one-half a cent; four fingers and the thumb extended and spread apart, five-eights of a cent; 
four fingers and the thumb extended but pressed together, three-quarters of a cent; hand 
clenched with the thumb alone extended, seven-eights of a cent. 

"Indicating the quantity the fingers are displayed vertically, each representing 5000 bush¬ 
els. The whole hand, fingers and thumb extended vertically represents 2 5,000 bushels. 

"A single transaction is after this fashion: A broker wants to buy 5000 bushels of Decem¬ 
ber grain at $1.24% a bushel, the last sale having been $1.25 a bushel. He extends his hand, 
fist closed, thumb extended, palm toward himself, and shouts his offer. His words may be lost 
in the volume of sound but his signal is seen by a broker across the pit who is willing to sell 
at that figure, and the signal is answered. The buyer raises one finger vertically, indicating that 
5 000 bushels are wanted and a nod accepts the offer. The transaction is complete. The buyer 
notes on the blue side of this trading card ’5—Johnson 1:24%,’ the blue side denoting a pur¬ 
chase, while the seller notes on the red side of his trading card, red denot¬ 
ing a sale, '5—Smith 1.24%.’ 

"The whole transaction took a fraction of the time it has taken to 
read the description, and under the rules of the Board of Trade the trade 
is as binding as though it had been a formal contract drawn by legal talent, 
signed, witnessed and delivered in duplcate after prolonged negotiation. 

"Multiply this transaction with its shout and its signals by hundreds 
occurring simultaneously; add the noise of a multitude of clicking tele¬ 
graph keys; repeat it in every pit augmented by strong lunged calls for 
scurrying messengers and the shuffle of a thousand feet and you have the 
roar cf the exchange. A roar meaningless to the superficial observer but 
filled with meaning to the initiated, who hear in it the voice of the world 
bargaining for the great primal necessity—food. 

"From the morning gong until the triple clang of the great bell above 
the gallery tolls the close of the market the clamor and tumult continue, 
and to this resounding accompaniment the stream of grain from the harvest 
fields of the world takes its course, supplying the needs of the nations. 



PRICE CODE 








140 


THE EXPANSION OF ECONOMIC CONCEPTS 


"As each transaction is completed in the pit it is noted by a trained observer on a raised 
platform, and transmitted to a telegrapher stationed on the 'bridge,’ an elevated gangway in 
the center of the exchange, and by him ticked to the man at the quotation blackboards and to 
the offices of grain brokers. On the blackboard the last quotation or sale price is chalked in 
plain view until it is superseded by a different price. 

"The changing quotations are sent broadcast over the land by telegraph, by the com¬ 
mercial market bureaus and by the newspapers so that the price at which grain is being bought 
and sold in Chicago is known and the changes observed almost instantaneously in far distant 
places. 

"With a knowledge of the price code the onlooker in the gallery may follow a transaction 
in the pit below. On the blackboard at the rear of the sample tables the latest price of grain 
is displayed. Suppose it is $1.80 I / 8 . You see a trader signaling excitedly with two fingers ex¬ 
tended. He is offering the grain at $ 1 . 80 '/ 4 . An answering motion comes from across the pit 
or from beside him. A finger points up. 5000 bushels are wanted. He nods. Both make a quick 
notation on their trading cards. You have witnessed a sale and a purchase. 

"Not the least of its virtues is the inflexible code of honor inculcated and enforced by 
the Board of Trade which makes these signalled trades as binding as more formal methods. 

"By means of a net work of telegraph wires, converging at the stations at the right of 
the pits, the grain trading of the entire country centers here in the few hundred square feet 
of the floor of the exchange. 

"There is a closer relation between the cash grain and futures pit than is observable on 
the surface. 

"Ownership of any commodity implies risk, and ownership of grain is no exception. In¬ 
deed, because of the constant change in prices, forced by the law of supply and demand on a 
world basis, the owner of grain is constantly subject to the hazard of lower prices.” 

Commodities Not Adapted to the Exchanges. —The influence of the 
law of supply and demand is just as certainly present in connection with 
commodities not quoted on the exchanges as in the case of those there 
quoted. For many of these commodities the laws at work determining their 
prices are so sluggish as to bring about great confusion in the minds of the 
producers and consumers. We do not mean to imply that the dealers in com¬ 
modities which find their market on the organized exchanges are not often 
also confused in the face of the operation of the law of supply and demand. 
In Connection with these commodities, however, the dealers are less likely 
to behave with injudiciousness than they are with regard to commodities 
which do not find a ready market. 

Since the great majority of economic goods do not find their market 
through organized exchanges proper action in their regard is of greater 
significance than with those commodities which do pass through the organ¬ 
ized exchanges. 

Goods not quoted on the exchanges may have a good market neverthe¬ 
less. Or they may have a poor one. The mere fact that they are not quoted 
on the exchanges does not of necessity mean that their market will be poor. 
An article like foreign exchange has almost, if not quite as perfect a market 
as stocks and bonds. Foreign exchange is not quoted on the exchanges, 
whereas stocks and bonds are. Yet the news agencies and channels of trade 
are so wide open for foreign exchange that the rates are nearly as uniform 
as the price of any security. In fact speculation, hedging, and all of the 
other phenomena of organized exchanges are present in the foreign exchange 
transactions. 


REACTIONS TO LAW OF COMPETITIVE PRICES 


141 


In contrast with this is the market for labor. In spite of the fact that 
one hesitates to call labor a commodity, for the purpose of economic analysis 
it has thus to be spoken of. Labor, then, the most important of all com¬ 
modities, has probably the poorest of all markets. The poorness of the labor 
market gives rise to one of the most vexing of economic phenomena—that 
of unemployment. If labor had a perfect market, unemployment would be 
as unlikely as the inability to sell cotton or wheat. 

An article has a good or poor market according as there is a ready or 
poor adjustment of supply to demand. It results from this that the most 
constructive thing that can be done for any article is to remove obstacles 
that stand in the way of the ready adjustment of supply schedules to demand 
schedules. Although a problem of this kind belongs to more specialized studies 
of marketing processes, something can be said here of the logical plan 
of procedure. 

1. Preliminary Considerations. 

(1) Some Articles Naturally Have a Sluggish Market .—These are likely 
to be illusive with regard to the quickness of the response to any treatment. 
In this connection producers may sometimes be deceived into believing that 
goods which they are offering are not under the influence of the law of 
competitive price. They may thus be led to believe that organized selling 
agencies can arbitrarily raise their prices. Soon they will find to their surprise 
that an arbitrary price policy will be forcing other goods on the market 
which cut under their arbitrary prices. From that they may be led to 
devices for maintaining the market that are beneath the dignity of re¬ 
spectable men. 

Sluggish market conditions may have the reverse effect. Persons may have 
articles which should really have a good demand. But it may take time for 
the demand to be awakened. It is said that it took twenty years for the 
dictaphone to become standard equipment for executive offices. One should 
be careful to discover whether the fact that competition is not evident 
is merely an indication of a sluggish market, or the indication of some¬ 
thing else. 

(2) Different Types of Commodities Require Different Treatment .— 
Some commodities have an established demand. Others have to have the demand 
created. Those commodities which have an established demand require little 
if any treatment for the demand side of the schedules. It is on the supply 
side that attention must be centered. Most agricultural commodities that do 
not find their market through the organized exchanges belong to the class 
of goods which have an esablished demand. Who would think of attempting 
to cultivate a taste for eggs, or milk, or watermelons, etc.? For these com¬ 
modities the sellers in most places have simply to give attention to agencies 


142 


THE EXPANSION OF ECONOMIC CONCEPTS 


which smooth out the supply side of the schedules so as to secure the most 
that the market will afford. 

Other commodities require attention on both sides of the demand and 
supply schedules. They are popularly known as specialties. They have to be 
“introduced.” Examples of these are numerous. Commodities of this kind 
may administer to human wants, but men may not have come to associate 
definite articles with their wants. Naturally when attention has to be given 
to both sides of the schedules the problem of adjustment of supply to demand 
is much more complex. 

2. Positive Acts of Adjustment of Supply to Demand. 

(1) Cooperative Selling Agencies .—Goods with an established demand 
which do not find a market through the organized exchanges are usually 
well adapted to the cooperative selling agencies. Some persons are too much 
inclined to jump to conclusions with regard to the place of cooperation 
in the marketing process. Cooperation is not a panacea. It should be employed 
only when it can be shown that cooperative treatment adapts itself to the 
problem under consideration. It should be remembered that the same law 
that is at work in setting the prices of goods offered through cooperative 
agencies is at work in determining the prices which middle-men charge for 
their services. Unless the law is defective in its operation on the men who 
supply these services, it stands to reason that little could be done by creating 
cooperative sales agencies. 

The fact is that serious harm might result from the creation of duplicate 
sales agencies when the ones already in existence are functioning as eco¬ 
nomically as could be expected. In other words, unless the cooperative sales 
agency can show a reasonable possibility of lowering the expenses of selling 
by providing for sales through the cooperative none should be formed. 

There are at least three conditions that offer opportunities for successful 
cooperative sales agencies. One occurs when the buyers are so organized as 
to form a “buyer’s market”—a monopoly of demand. Organized sellers 
could then meet the buyers face to face and demand a price justified by 
the situation. Another condition would prevail when the established agencies 
are not operating efficiently. An example of this appeared in the loan agencies 
which served before the establishment of the Farm Loan System. Similar 
situations might prevail in other fields. 

A third condition would be characterized by the disjointed market. The 
demand is already established but goods do not readily flow to the buyers. 
The price of the article varies widely from one center to another. There is 
an absence of any coordinated method of adjustment of demand to supply. In 
cases of this kind the cooperative agency could do a fine service in relieving 


REACTIONS TO LAW OF COMPETITIVE PRICES 


143 


the pressure on the market at certain points and diverting the goods to 
centers where they are more keenly desired. If producers act independently 
when the market is disjointed, they are likely to rush headlong into high-price 
areas and lose by not having their goods at a certain market point at the 
most favorable time. A cooperative selling agency can prevent such a 
contingency. 

Some high authorities on corporation finance have advanced the conten¬ 
tion that a private corporation could probably operate more economically 
than a big cooperative selling agency like that of the California Fruit 
Growers Exchange. But the fact is that the private corporate agencies did 
not cover the field now covered by the Exchange. Nor did the independent 
commission merchants successfully perform the marketing function now so 
excellently performed by the cooperative sales agency. 

(2) Advertising .—Skillful advertising has been the salvation of many 
a seller. But just as cooperation is not a panacea for all marketing ills, 
likewise advertising is not beneficial to all commodities. Some types of goods 
and services are actually injured by advertising, others respond but slightly, 
whereas there are many which respond readily to the influence of the ad¬ 
vertiser. So certainly is this last true that advertising itself has become a 
business of large proportions. 

Just what is the place of advertising in the gamut of economic goods 
and services is hard to say. It is primarily associated with specialties. It is 
doubtful that advertising could to any great extent increase the consumption 
of a commodity like wheat flour. It might, nevertheless, increase the con¬ 
sumption of one brand of flour at the expense of another. The total con¬ 
sumption of some commodities might actually be increased by advertising. 
That is certain to have happened recently with regard to cigarettes. Then, 
too, it is possible that advertising might stimulate the consumption of special¬ 
ties as a whole. It has almost without question increased production as well 
as consumption in recent years. It could not increase the one without in¬ 
creasing the other. A newly awakened desire is an urge to secure the pur¬ 
chasing power with which to acquire the object of that desire. The only 
effective way to secure that purchasing power is to produce something that 
the seller of the commodity wants in exchange for it. If the productive effort 
created in response to the new urge happens not to create something that 
the seller of the desired article himself wants, any valuable commodity 
brought into being will have the same effect. For purchasing power is all' 
that it takes to secure the coveted article, and any valuable commodity has 
the faculty of commanding purchasing power. It is clear, therefore, that 
advertising has the power of stimulating consumption and production 
in general. 


144 


THE EXPANSION OF ECONOMIC CONCEPTS 


Advertising works on both sides of the equation of supply and demand. 
The advertising agencies are so well developed today that there is little 
excuse for those goods and services that lend themselves to effective sales 
through advertising not to find their market. 

(3) Government Assistance .—Goods and services which do not find a 
ready market through advertising, and which lend themselves but poorly 
to privately organized exchanges, whether cooperative or commercial, some¬ 
times perish without finding a market while society suffers from the lack 
of them. How effectively to bring about an adjustment of the supply to 
the demand for goods of that kind is a question of great moment. 

How many of those goods and services there are is a problem which is 
itself of no small consequence. Special studies in the field of marketing would 
do well to identify and classify them. There are, however, at least two that 
stare us in the face. One is labor and the other is works of art. 

We have already alluded to the fact that of all commodities labor has 
the poorest market. Works of art follow as a close second. 

The labor union is best thought of as a cooperative selling agency for 
labor. The accomplishments of labor unions are certainly worthy of com¬ 
mendation. Without them laborers would probably be worse off than artists. 
With them the laborers have been materially helped. 

But one does not have to contemplate the effect of labor unions on the 
problem of ready adjustment of the supply of various grades of labor to the 
demand, for any great length of time, to discover that the union is at best 
only a halting solution to the problem. Several outstanding facts give evi¬ 
dence of that fact. (1) The union is as a rule keenly disliked by the em¬ 
ployers. The most that can be said for their accomplishment in overcoming 
this dislike is that of a tolerant attitude toward them. Where that has been 
secured it has been done largely because of the fact that the union helps 
considerably in meeting the need for reliable and efficient labor. (2) Vast 
groups of laborers can never be included in the unions. At least three groups 
of laborers do not readily become members of unions. These are: professional 
men, workers in the so-called "trustified” industries, and the vast army of 
unskilled laborers. The first do not join largely because unionism offends 
their sensibilities. The second are afraid to join. In the trustified industries 
the innate hatred of unionism has been successful in defeating efforts at 
unionization. The third—the largest group of all—are as a whole simply 
unorganizable. 

(3) Unions fight each other. Probably the most annoying problem which 
faces organized labor is that of jurisdictional disputes. Organizations some¬ 
times become so completely deadlocked in jurisdictional disputes that em¬ 
ployers who have become accustomed to depend on unions for their labor 


REACTIONS TO LAW OF COMPETITIVE PRICES 


145 


supply are for weeks and even months forced to cease operation on account 
of the fact that they consider it unwise to offend one of the groups by 
siding with another. Any projected solution of the problem of adjustment 
of supply to demand that contains the outstanding defects here noted in labor 
unions certainly cannot be championed as an effective solution to the problem. 

To some extent, also, artists have, as a class, been able to handle the 
problem of the marketing of their products by cooperative sales agencies. 
These do not take the form exactly of artists’ unions for very seldom are 
artists hired. Their products are usually sold directly to the consumers. Not 
being hired they have no one with whom to bargain collectively for their 
services. The magic phrase "collective bargaining” can have little significance 
among artists. 

At present practically the only outlet for artists’ products is that of the 
art exhibit. These are usually sponsored by some sort of an art association 
large or small. Kind-hearted men of wealth are sometimes persuaded to offer 
prizes, and the wistful artist awaits longingly the decision of judges—fre¬ 
quently a group of persons for whose ability the contestant has little respect. 
The better artists do not willingly accept appointment as judges. They wish 
to compete for the prizes. Prizes are not infrequently awarded on bases that 
would precipitate a riot at a county fair. Yet the privately sponsored art 
exhibit at the present writing is the principal method of discovery of new 
ability among artists. These, we assert, are only halting efforts at the estab¬ 
lishment of cooperative marketing agencies for works of art. 

The would-be purchaser of good pictures is almost as much at the mercy 
of the situation as the starving artist. Too few of us have any well developed 
standards to employ as a basis for the choice of a painting. We know that 
there is such a thing as a cultivated taste and we dare not spend several 
hundred dollars for what we think good art and thereafter be considered 
as having acted foolishly. The result is that the situation is worse than is 
true of the labor market. The logical way out for commodities of this kind 
is now before us for consideration. 

Here is the one place where the government can come effectively to the 
assistance of the situation. Probably no one question has been of greater 
concern to economists than that of the relation of the government to business. 
The laissez faire economist thought that the less done by the government the 
better. The laissez faire point of view is no longer accepted in professional 
circles. 

In a number of ways the government already takes a hand in the matter 
of market information. But, strange as it may seem, the action relates to 
those articles that least need it. No intention is evinced of condemning the 
steps thus far taken in so far as they relate to constructive action in bringing 
about a more ready adjustment of supply to demand. The government, 


146 


THE EXPANSION OF ECONOMIC CONCEPTS 


however, is much more likely to place obstacles in the way of ready adjust¬ 
ment than it is to facilitate the easy sale of goods. This is due to the fact 
that all too frequently special interests are able to dominate governmental 
agencies. But in a number of ways the government already facilitates the 
adjustment of supply to demand. Illustrations are: the work of the Bureau 
of Crop Estimates of the United States Department of Agriculture, the 
Commerce Reports, and special information agencies which permeate our 
whole administrative system. 

But these, as noted, do not represent conscious efforts to help the market¬ 
ing situation of the commodities which need help the most—those com¬ 
modities which do not lend themselves readily to cooperative marketing, 
those commodities which do not find a market readily through organized 
exchanges, and those commodities which are not well adapted to advertising. 
Here of all places the government help is most needed, and it is here that it is 
usually least developed. 

Details of Government Assistance. —An extended discussion of the 
details of government assistance in connection with the problem here under 
consideration cannot be given for lack of space. There are, however, several 
points of outstanding significance: Some progress has already been made. 
Efforts should be exerted to build on the foundation already laid. 

The greatest strides have been made in connection with labor, taking form 
in the public labor exchange. In the more advanced industrial countries 
comprehensive labor exchanges already exist. In others—and in this respect 
we are forced to classify the United States among the others—at the present 
writing only small beginnings have been made. If those sponsoring the 
movement looking toward labor exchanges would proceed with vision and 
foresight, with a comprehension of the great purpose labor exchanges are in¬ 
tended to serve, many of the present labor exchanges would be relegated to 
the scrap-heap, and a coordinated system of municipal, state, and national 
exchanges would be created. We do not mean to imply that the public labor 
exchange would completely solve the labor problems, for there are other 
aspects than unemployment. But there is no reason why agencies should 
not be established so that information should be readily available to men 
desiring employment whether or not jobs are available which they are com¬ 
petent to fill; and persons desiring hired help could know whether or not the 
help is available. 

Slight beginnings have already been made in the direction of providing 
governmental agencies for the adjustment of the supply to the demand for 
artists’ products. These appear in connection with a few municipal museums, 
and in the few instances where attention is given to real works of art in 
state and county fairs. Few of these, however, offer anything in the nature 


REACTIONS TO LAW OF COMPETITIVE PRICES 


147 


of definite standards toward which the struggling artist can aim. Most of 
them are looking for geniuses instead of attempting to help the moderately 
capable to improve their standards. If persons could be found to sponsor 
movements toward well developed and well coordinated points of appraisal 
of works of art so that the innumerable would-be artists could be made to 
understand why their works are inferior, and others that have merit, even 
though only of secondary importance, could find assistance, a great step 
would be taken in the direction of adjustment of the supply to the demand 
for artists’ products. Those who desire things in good taste would thus 
have a place to go with assurance of securing them. The struggling artist 
would also be given a chance to prove his or her talent. 

As the situation now prevails one of the greatest of human needs is only 
poorly served simply because of the fact that there is a very unsatisfactory 
automatic adjustment of supply to demand. The ordinary laws of competition 
work poorly here. They need to be given a boos* by the government. 

The author speaks with assurance with regard to principles of opera¬ 
tion essential to ideal labor exchanges. Students of labor problems have 
already set these out as follows: 

"Recent experience has shown that the essential administrative machinery 
required to make a state or a national system of labor exchanges successful 
must include: 

**1. A civil service provision that will make tenure of office secure for every member of 
the staff, including the director, that will eliminate the incompetent political worker and 
attract capable people to make a career of employment in the service. 

“2. A joint committee of representative employers and workers to advise in determining 
all policies of management, and to assist in the selection of the staff under civil service, so 
that they may have confidence that the members of the staff will conduct the work impar¬ 
tially as between capital and labor. The members of the committee should be designated by 
the interests which they are chosen to represent. 

“3. An accurate and reliable system of records designed to show quickly and completely 
the character of the work of the offices and to furnish authoritative statistics on the problem 
of unemployment. 

"4. Uniform methods and records for the whole system of exchanges and cooperation 
and interchange of information among offices, so that comparisons could be made easily and 
labor transferred quickly from place to place through the offices.”—Furniss: Labor Prob¬ 
lems, p. 63. 

The problem is certainly different in many particulars for works of art. 
But it is not incapable of solution. The author dares to offer the following 
practical suggestions in this regard: 

1. The provision of at least one publicly supported museum of art for each state, with 
feeders for it in each county or district of the state. The central museum could set the 
standards and exercise general supervision of the branches. There is at least one museum of 
the kind—that of the State of New Mexico—and the results are certainly encouraging. 

2. The museum and its branches to be under the control of an unpaid board of prominent 
citizens—persons who have an appreciation of good art but not necessarily artists themselves. 
Experience has shown that a much higher quality of service can be secured by having a 
board of the kind unpaid. There are always a number of public-spirited persons who are glad 
to give their time and services to the general work of uplifting the standards of the common¬ 
wealth. 


148 


THE EXPANSION OF ECONOMIC CONCEPTS 


3. The details of administration to be left almost entirely in the hands of the board. 
Certain restrictions will have to be made in the act of legislation establishing the system. 
These restrictions should be few and select—probably best precipitated from suggestions made 
from outstanding artists of the nation. 

4. There would of necessity have to be a curator paid a salary commensurate with the 
dignity of the position. In addition one or more assistants would naturally be employed as 
approved by the board. 

5. A plan of entry and classification should be provided so that all efforts which have 
merit of any kind would be made available to the public in the following ways: (a) by 
regular public exhibitions, (b) by temporary leases of paintings, or other works of art, to 
responsible persons who do not feel able to buy them, and (c) by sale to those who wish to 
buy. 

6. The price of the articles offered for sale to be in the first instance set by the artists 
themselves. In time, however, we should expect the law of supply and demand to operate 
to establish a more or less uniform price for works of art of approximately the same grade. 
At this time the price of a work of art is one of the most indefinite things in the world. 
That fact is the consequence of the present chaotic condition of the market for them. With 
a better organized market we should expect rather definite standards of prices to guide both 
the sellers and the buyers. 

7. The system to operate on a commission basis. It is not assumed that the system here 
suggested will ever become self-supporting. That should not be expected of it any more than 
of an educational institution, or a public library. But the income realized from the com¬ 
mission charged could very helpfully be employed to purchase certain outstanding works of 
art, and in offering prizes for works of exceptional merit. 

There may be other goods or services than labor and works of art that 
require the treatment of the kind here indicated. If they exist and it can 
be shown that they are neither adapted to labor exchanges nor to the above- 
mentioned method of providing a market for works of art, the logical con¬ 
clusion is that a program of action adapted to them should also be worked 
out. Everything that the government can do in the direction of helping the 
market for goods not now being readily sold, if these goods have value, will 
react favorably on the market for goods which are already provided with 
channels of sale. That proposition is so evident that it barely needs proof. 
An increase of the purchasing power of any persons who are running low in 
their ability to share in the world’s goods automatically improves the markets 
as a whole. 

Competitive Prices and Economic Progress. —Business men are al¬ 
most completely at the mercy of economic progress. Efforts to provide any¬ 
thing more than a temporary relief from its consequences are usually fruitless. 

At the present writing (1931) the desperate conditions under which 
the coal miners are living is hardly traceable to any other cause than that 
"the bottom has fallen out of the market for coal.” The development of 
hydro-electric plants, the extensive use of electricity and natural gas and 
petroleum products for power and heat, have made such inroads into the 
market for coal that coal mining presents an organization fitted to supply 
coal far in excess of what the market will take at the price which will 
enable those employed in the coal business to live comfortably. The result 
is that those persons who are caught in the toils of the coal-mining industry 
are in a desperate situation. 


REACTIONS TO LAW OF COMPETITIVE PRICES 


149 


Many other similar instances could be mentioned. When we contemplate 
a situation of this kind we can only stand amazed in the face of the heart¬ 
lessness of the pursuit of progress. The net results are, of course, greatly in 
favor of economic progress. But it is hard for those who are forced to find 
a new footing to be reconciled to the social order which throws them into 
the streeets. 

It is because of the fact that the business man is just as much at the 
mercy of progressive changes as are the laborers that the laborers are thrown 
out of their positions, or forced to work shorter hours when they prefer 
not to do so. Whole industries are sometimes left in the lurch. 

As already noted, the most frequent reaction of the business men to 
changes of this kind is that of attempting to break the neck of the dragon 
which is breaking the bones of antiquated productive agencies. The chain 
store offers a superior method of merchandising. Independent merchant asso¬ 
ciations are formed, if possible to handicap by legislation, or otherwise, 
the agency which they are unable to meet by fair methods of combat. The 
social order is honeycombed with would-be obstructions to economic prog¬ 
ress. But the order of free competition is well enough established in our 
jurisprudence and social consciousness finally to allow the superior methods 
to dominate. When the producer asks for protection at the expense of social 
progress, in the end consumer interest tends to dominate. Such is the rule 
of progress. 

We are reminded of a statement of the president of the National Biscuit 
Company, when that gigantic corporation came into being: 

"When the Company started it was believed that we must control competition, and to 
do this we must either fight it or buy it. The first meant ruinous war of prices, the second 
constantly increasing capitalization. Experience soon proved to us that instead of bringing 
success, either of these courses, if persevered in, must bring disaster. This led us to ask our¬ 
selves whether the Company, to succeed must not be managed like any other large mercantile 
business. We soon decided that within the Company itself we must look for success. 

“We turned our attention and bent our energies to improving the internal management, 
to getting the full benefit from purchasing our raw materials in large quantities, to econo¬ 
mizing the expense of manufacture, to systematizing our selling department, and above all 
things, to improving the quality of our goods. It became the settled policy of this Company 
to buy out no competition, and to that policy, since it was adopted, we have steadfastly 
adhered and expect to adhere to the end.”—Lough: Business Finance, pp. 3 65-6. 

Neither does the author here have any remedy to offer for those who are 
likely to be thrown aside in the battle with legitimate competitors except that 
of fighting the demon with his own weapon. Unless a business can survive 
because it offers a service of greater utility than another existing or potential 
one the competitive order tends to relegate it to the scrap-heap. 

Enterprises Which Thrive on Price Changes. —The competitive 
order is true to form in that within itself it gives rise to agencies which 
have as their objective the corrective of the worst features of the system. 
This statement is not universally true, but it does apply to the matter of 


150 


THE EXPANSION OF ECONOMIC CONCEPTS 


price changes. The best developed of these relate to supplementary phe¬ 
nomena of the organized exchanges. The most interesting of all is that 
of hedging. 

Hedging .—Hedging is a sort of insurance against loss from price changes. 
The following quotations are given for the reason that they set out in a 
very clear way the fundamental characteristics of hedging: 

"Many of the speculators in staples, wheat, corn, wool, rarely handle the material things, 
the real products. They make it their business to study the world conditions and to buy or 
sell for future delivery. Regular merchants buy and sell 'futures’ from or to these men; 
that is, they promise to deliver or take the produce or pay the difference between the con¬ 
tract and the actual price at the time of maturity. Mere speculators on the produce markets 
may and do at times thus perform service as risk takers. When a miller buys ten thousand 
bushels of wheat that will remain in the mill three months before they are marketed as actual 
flour, he 'hedges’; that is, he at the same time sells that number of bushels to a speculator for 
future delivery. If wheat goes down in price the loss on the actual wheat is balanced by the 
gain on the 'future’, and vice versa. Or selling flour for future delivery the miller buys a 
future in wheat; if wheat goes up in price, the miller’s loss on his contract for flour is 
offset by the gain on the 'future.’ In either case he cancels the chance of loss or gain, giving 
product on his hands. To him this is legitimate insurance, for he is striving not to create an 
artificial risk, but to neutralize one that is inseparable from the ordinary conditions of his 
business. 

"How can the speculator profit if the miller in the long run benefits? There are unsuc¬ 
cessful speculators and at any rate their losses go to the successful as a sort of gambling profit. 
But, further, the sales to legitimate purchasers should net a gain to the abler speculator. In 
proportion as his estimates are correct, there will remain a regular slight margin of profit to 
him. If he sells wheat at eighty-five cents to be delivered in three months, he expects it to be 
a little less at that time; if he buys a future ha 'xpects the price to be a little more at that 
time. In the long run the speculator to be successful must buy at a little less and sell at a 
little more than the price really proves to be. This means that the merchants in the long 
run pay something for protection against changes in prices, just as they pay something for 
insurance. And yet this is the cheapest way to reduce risk, and a man engaged in milling is, 
it is said, at a disadvantage if he neglects this method of insurance.”—Fetter: Economic 
Principles, pp. 3 66-7. 


HEDGING ILLUSTRATED 

"Hedging may be defined as the making of a pair of transactions of opposite nature, in 
which the loss (or profit) on the original transaction is offset by a corresponding profit (or 
loss) on the hedging transaction. If the original transaction begins with a purchase and ends 
with a sale, the hedge must begin with a sale and end with a purchase. We may illustrate 
a hedging transaction as follows: Assume that a grain exporter in Chicago has purchased 
wheat to be sent to Liverpool, there to be sold by a broker. There is normally a difference 
in prices between the exporting market and the importing market, the margin by which the 
latter exceeds the former being sufficient to cover the costs of exporting and importing and 
a sufficient profit to keep the traders in the business. Let us assume that this difference is 
normally twenty-five cents on a bushel of wheat. We may further assume that our exporter 
is satisfied with the trading profit remaining after transportation and other charges have been 
deducted from this original 'spread,’ and that he is not seeking a speculative profit from 
price change. That is, he is dealing on the margin between prices in different markets at the 
same time: not on the divergence between prices at different times. He can avoid the fluctua¬ 
tions in price by hedging. On September 1 he buys wheat in Chicago at $2.00 a bushel and 
on the same day he sells for delivery in the future some product, the price of which he 
believes will move with the price of the wheat he has bought. In practice this would likely 
be the same product, wheat, for delivery some time in the future, say in the following May. 
He, therefore, enters into a contract, whereby he agrees to deliver wheat of a specified grade 
on the Chicago market in the following month of May. For this promise he receives, say, 


REACTIONS TO LAW OF COMPETITIVE PRICES 151 


$2.07 a bushel, on the wheat involved. Prices then, on the day of purchase, September 1, as 


follows: 

Chicago 'spot’ price - -- -- -- -- -- $2.00 

Liverpool ‘spot’ price - -- -- -- -- - - 2.25 

Chicago 'May’ price - -- -- -- -- -- 2.07 


The contract to deliver wheat in the future has a market value, which will normally 
rise and fall with the price of actual or 'spot’ wheat, e.g., wheat deliverable in the present. 
The Chicago spot price and the Liverpool 9pot price also have a marked tendency to move 
together. Now suppose that on October 1, when his wheat arrives in Liverpool, the price is 
only $2.05, a decline of twenty cents. After allowing for transportation costs, commissions, 
and his normal trading profit, he has lost twenty cents on his exported wheat due to price 
change. But now we can safely assume that the price of 'spot’ wheat in Chicago has also de¬ 
clined by twenty cents and, likewise, the price of 'May’ contracts has declined. He can, 
therefore, buy back his future contract for, say, $1.87. It is not necessary that he should 
purchase the original contract which he entered into on September 1. If he buys a May 
contract for the delivery of the same amount of wheat which he is under obligation to deliver 
in May, it is clear that, for all practical purposes, he is out of the transaction, for his duty 
to deliver wheat in May is just offset by his right to receive wheat in May. He received $2.07 
for entering into this future contract; he is able to free himself of it for $1.87. He has thus 
made a profit of twenty cents a bushel. This offsets exactly the loss from price change on 
the wheat exported.”—Griffin: Principles of Foreign Trade, pp. 305-7. 

It is seen from the quotations that hedging is not limited to any one 
type of price change. It applies as well to the spinner as it does to the miller. 
It also applies as well to foreign exchange transactions as it does to com¬ 
modities sold on foreign markets. If, for instance, an exporter of cheese 
were asked to quote a price on a shipment of cheese to be delivered within 
six months, the foreign exchange quotations at the end of that time would 
materially affect the price at which he might sell the cheese. To relieve 
himself of any danger of loss because of fluctuation in exchange rates the 
exporter of cheese could secure a quotation from a dealer in foreign exchange 
as of six months in the future. Basing his calculation on that quotation the 
exporter could make his price for the shipment of cheese. In this instance, 
however, it is the dealer in foreign exchange that needs to hedge so as to 
be insured against loss by the fluctuation in exchange rates. This he does by 
selling the same amount of exchange deliverable six months from date. 
Then whatever happens to the rate will be of small importance to the 
broker. He has made his profit by purchasing the exchange at a lower price 
than that which he received for it. His relation to the exchange market is 
as secure as that of the miller or spinner. 

We see from this, therefore, that the speculator is a business man. His 
money is made by buying and selling "at a profit.” An error is quite wide¬ 
spread with regard to the source of the speculator’s gains. It is frequently 
stated that his gains grow out of the losses incurred by the amateur specu¬ 
lators—or gamblers on the exchanges. Such an explanation of the specu¬ 
lator’s gains is far from the true interpretation of the phenomenon. In 
the long run the losses and profits have to balance. The fact is that the 
exchanges would perform their services more efficiently if the amateurs 
were not present on the market. Their influence is harmful because when 





152 


THE EXPANSION OF ECONOMIC CONCEPTS 


prices are rising they crowd in on the demand side and push them to in¬ 
ordinate heights, and when they are falling they crowd in on the supply side 
and press the prices below their necessary level. At any rate the legitimate 
speculators help to stabilize the market for commodities which are sold 
through the exchanges by the fact of the futures market. And they furnish 
insurance against price changes to persons not skilled in speculation so that 
they may make their gains from the utilities which they are trained in supplying. 

Price Forecasting .—Another manner of "cashing in” on price changes 
is that of price forecasting. Certain skillful statisticians make attractive in¬ 
comes in this way. We have had, naturally, a somewhat larger development 
in this particular in connection with stock exchange transactions than in 
connection with the other organized exchanges. It is now possible for sub¬ 
scribers to certain publications to be given in code tips on the market so as 
to be guided in their decision as to what to purchase. 

As long as we are to have gambling on the exchanges it is probably well 
that we have these tipsters. Persons who act on the information sold to them 
for their special benefit are at least basing their action on some kind of 
conscious plan of procedure instead of following blind chance. It is hard for 
us to see, however, why it is that any one who might know the future be¬ 
havior of the prices on the exchanges would even sell the information. Why 
should he not act on it himself? The greatest fortunes are capable of being 
made by acting on superior knowledge of speculative market conditions. 

Really there can be little if any fundamental difference between these 
agencies which sell tips on the exchanges than the ubiquitous persons who 
sell tips on the horse races. We are informed that some of these tipsters have 
a good record in picking the winning horses. 

Manipulation of the Market .—"Some morning you may observe that 
certain stock, long quiet, has suddenly become active. Each sale of several 
hundred shares is a fraction above the previous sale and after a few min¬ 
utes the stock sells four or five points higher than it did before this brisk 
little movement started. Then prices begin to recede and perhaps after 
half an hour the stock is quiet again at the same old price. 

"Here is the explanation: Mr. Pool Manager knows that the average 
man likes to tickle his vanity by getting a little better price for what he 
has to sell than other people are getting. Suppose a stock has been selling 
for a long time at $40. A number of holders of such stock say to themselves: 
T won’t take $40 but I’ll take $43.’ Others put their price at $44 or $45. 
They don’t wait until the stock is selling at the higher figure, but place their 
selling orders in advance. Their open orders may be on the brokers’ books 
for weeks before they can be executed. 


REACTIONS TO LAW OF COMPETITIVE PRICES 


153 


"The pool manager perhaps makes it worth the brokers’ while to tell 
him just how many open orders are on his books, and at what prices. When 
there are enough to be important the pool manager says to his broker, or 
brokers, 'Buy all stock that is offered between 40 and 45.’ 

"That brings about the sudden run-up, like a mouse darting out of its 
hole for a bit of cheese and back again. If the enterprise were not quickly 
carried out, many who had orders in at 42 would change their mind and 
raise their price. The pool must clean up all open orders on the books before 
the public has time to learn what is going on. Then the price promptly 
begins to recede. 

"Pool managers even reckon with such human factors as people’s number 
habits. Ask almost anybody suddenly to write down a number between one 
and ten and the chances are two out of three that he will write seven. For 
some unknown reason, seven is a favorite number with us. Likewise numbers 
ending in either five or zero are handy numbers. According to census figures 
there are always more people aged 3 5 than either 34 or 36, simply because it 
is so easy to say 3 5 to the census man. A man seldom receives $26 a week, 
but often $25 or $30. 

"Now, these same number habits naturally are felt in the stock trans¬ 
actions—and pools know it. If you will look at a newspaper giving the high 
and low prices of all stocks in the entire year, you may observe a surprising 
number of stocks whose high for the year was a figure ending in four or 
nine—just under a multiple of five. The reason is that we think in round 
numbers and try to sell at a round number but don’t always succeed. 

"The majority of sellers are asking, let us suppose, 150 for a stock, 
but the best bid is only 149. Finally, enough sellers decide to take 149 to 
fill at least part of the demand. Then the price drops to 148 and lower. 
All who held out for 150 now wish they had accepted 149. Pool managers 
are clever enough not to wait for round numbers but to sell ahead of the 
price asked by others. 

"Reversing the process, the low price of your favorite stock is likely 
to be just above five or zero. We say of a favorite stock: 'If it goes back to 
90 I’m going to buy it.’ But more experienced buyers may get ahead by 
bidding 90*4 or 91. 

"Such tactics, which pools employ regularly, may seem unfair. The truth 
is, however, that every one of us who fools with the market tries to carry 
out the same technique—to buy cheap and sell dear. 

"Moreover, to give the devil his due, many pool operations probably have 
a benign influence, for they help to keep prices steady. Many of the most 
riotous advances in stock prices during the last year were made, not when 
a pool was operating, but when the uninformed public got excited and 


154 


THE EXPANSION OF ECONOMIC CONCEPTS 


kept on bidding up a stock, thinking not of its value, but only that it might 
sell still higher tomorrow. When realization suddenly comes that a price is too 
high, a drop of 20 or 30 points may occur in a single day. The pools often 
get the blame when the real fault is the greediness of the public.” (Fred 
C. Kelly: Stock Markets and Pools, November, 1928, American Mercury.) 

The fact that markets are manipulated on the exchanges is sometimes ad¬ 
vanced as an argument against the exchanges. It takes a very little business 
experience to know that there is a much greater manipulation—at least a 
greater opportunity to manipulate—the prices of goods not quoted on the 
exchanges. 

There is probably no better advice to any one or any group of people 
who contemplate any plan of a conscious control of competitive prices than 
simply: "If you do not know what to do don’t do anything.” 











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THE EXPANSION OF ECONOMIC CONCEPTS 


Jean Charles Leonard de Sismondi 

"Sismondi was a native of Geneva. His family was originally Italian, but took refuge in 
France in the sixteenth century, and migrated to Geneva after the Revocation of the Edict 
of Nantes. Here Sismondi was born in 1773. He is even better known for his two great works, 
L’Histoire des Republiques Italiennes and L’ Histoire des Francais than for his economic 
studies. He was a frequent guest of Mme. de Stael in Chateau Coppet, and among the other 
visitors whom he met there was Robert Owen. He died in 1842.”—Gide and Rist: History of 
Economic Doctrines , p. 173, note. 

"All his interest in political economy, so far as theory was concerned, was summed up in 
the explanation of crises; so far as practice, in the amelioration of the condition of the workers. 
No one has sought the explanation or striven for the remedy with greater sincerity. He is thus 
the chief of a line of economists whose works never ceased to exercise influence throughout the 
whole of the nineteenth century, and who, without being socialistic on the one hand or totally 
blind to the vices of laissez-laire on the other, sought that happy mean which permits of the 
correction of the abuses of liberty while retaining the principle. The first to give sentiment a 
prominent place in his theory, his work aroused considerable enthusiasm at the time, but was 
subjected to much criticism at a later period.”— Ibid, p. 173. 


CHAPTER IX. 


BUSINESS CRISES 

One of the surprises of the automatic system of production and distribu¬ 
tion was the fact that economic laws did not work with perfect adjustment. 
Under a system of laissez-faire the spontaneous adjustment of supply to 
demand, and the spontaneous working out of other economic forces, so 
glowingly visualized by Adam Smith, very soon gave evidence of a lack 
of perfect coordination. This lack of coordination made itself evident most 
disastrously in the appearance of what has come to be known as business, 
or economic crises. The fact that they have tended to pass through well- 
defined stages and have occurred at regular intervals have led certain 
students of the phenomenon to refer to them as business cycles. The author 
considers the term business crises a better appellation. The term cycle seems 
to imply a more or less superhuman phenomenon—like the phases of 
the moon. The term business cycle implies that man can only stand by, and 
at best prepare for the inevitable. The term business crisis, on the other 
hand, implies an occurrence which is more or less due to man’s own behavior. 
Since man’s behavior is not beyond his own control, it is hardly accurate 
to consider business crises beyond man’s control. This is true even though we 
conclude that man is not likely in the future to behave in such a way as 
to make crises unlikely to occur at regular intervals. 

During the last century and a quarter they have appeared in the following 
years: 1815, 1827, 1836, 1847, 1857, 1866, 1873, 1882, 1893, 1900, 1907, 
1914, 1920 and 1929. Any occurrence that has made its appearance at 
such regular intervals for so long a time might well be considered as a part 
of the nature of things. If a thing has happened once every decade for over 
a hundred years, we are right in assuming that it will happen in the future. 
True to form, the crisis of 1929 appeared on schedule time.* 

Characteristics of the Business Crisis. —Before we proceed with our 
review of the most significant efforts to explain business crises we should 
understand, if possible, what it is that we are observing. In order to do this 

*The periodicity here given is that of Jevons. W. C. Mitchell finds a shorter interval of 
time between crises. To the mind of the writer, Mitchell fails to differentiate special from 
general crises. 


157 



158 


THE EXPANSION OF ECONOMIC CONCEPTS 


it is necessary to make a distinction between the general business crisis and 
the special crisis. 

General Business Crises .—Sudden breaks come in trade. In most descrip¬ 
tions of general business crises it is stated that they are preceded by a sudden 
rise in prices after which as suddenly—more suddenly, in fact—there comes 
a slump in prices. While most crises have been associated with a rise and 
fall in prices, yet that has not been the case with them all. Consequently 
all that we can say with certainty is that the wheels of industry suddenly 
stop. Sellers are embarrassed with stocks of goods on hand which have 
been accumulated for purposes of meeting anticipated demand that fails 
to materialize. Without the ability to move their goods many business men 
find themselves facing accounts which they cannot pay. Persons dependent 
upon collections which cannot be made because of the inability of their 
debtors to move their goods likewise find themselves stalemated in their 
efforts to meet their financial obligations. Buyers, even when they have the 
purchasing power, use it grudgingly for fear that they too may be caught 
in the toils of the situation. Faced by an increasing stream of cancelled 
orders factory owners and other producers are forced to reduce their opera¬ 
tions and in many instances to close their doors altogether. This action 
throws thousands of workmen into the streets without jobs. Shops are 
glutted with good things of life spoiling for the lack of demand while the 
hungry crowds look longingly about without the wherewithal to buy. The 
wheels of industry seem to come almost to a standstill without any clearly 
apparent cause. This we call a general business crisis. It is general in the 
first place because practically all industries and trades are affected, and in 
the second place because the influence is not confined to any particular 
country but is worldwide in its sweep. 

The Special Business Crisis .—Crises which are not so widespread are more 
frequent and less disastrous. These occur more frequently and with little 
reason to be considered regular. They relate to one or at least a few major 
commodities, and are localized in nature. Sometimes a special crisis may carry 
in its train considerable disaster, but it is usually the result of a definitely 
assignable cause and relates to the good or service that suffers from that 
particular influence. The visitation of the fruit fly caused a crisis among 
the citrus fruit growers in Florida in 1928. A drought may cause the failure 
of an agricultural crop and bring about a crisis among a certain group of 
farmers. An artificially stimulated land boom sometimes brings disaster 
to thousands who have ridden for a fall, and so the story goes. If we were to 
tabulate the special business crises which have occurred during the last 
century the total would run into the hundreds. 


BUSINESS CRISES 


159 


While the special business crisis is of great significance, and may in 
certain instances be a contributing cause of a general crisis, it is not the 
special crisis that is our concern at this point. We are concerned with the 
general business crisis. 

The Relation of the General Crisis to the Price Level. —So fre¬ 
quently have business crises come at the end of a relatively long period of 
rising prices that they have generally been spoken of as more or less the 
consequence of a period of inflation of prices. 

For the purpose of examining the history of price trends a chart is included 
on the next page. The chart is reproduced from Edie: Money, Credit and Prices, 
page 214. If one will examine the chart critically one will observe that during 
the nineteenth century and the early years of the twentieth century there has 
been little correlation between price trends and business crises. Crises have oc¬ 
curred as certainly during periods of falling prices as they have during periods 
of rising prices. Between the years 1815 and 1 85 5 the general trend of prices 
was downward. In this period there were four crises. Similarly from 185 5 to 
1870, with the exception of a few years marked by the crisis of 1857 the 
general trend of prices was upward. Sight is not lost of the fact that during 
the Civil War paper money prices went very high. But at no time during 
the period after 1857 were the prices as a whole not higher than they were 
in 185 5. From 1870 to 1895 the general trend of prices was downward. 
Probably the worst crisis in modern times occurred in the year 1893. That 
crisis was devoid of any aspect of the phenomenon of a sudden rise in 
prices heralding a drop. Since 1896 prices have taken an upward swing 
and have continued thus at least till 1920. In that year and immediately 
following occurred the deflation of credits after the great war. With the 
exception, however, of the inordinate rise of prices from 1914-18 the gen¬ 
eral trend of prices has been upward. At no time since 1895 have prices 
been as low as they were in that year. It is hard to see, in view of these 
facts, that one can assert that the business crisis necessarily is associated with 
a rise and fall in prices. The fact is, it seems, that the phenomenon of the 
business crisis must be considered as something distinct from the mere fact 
of price changes. If that is true the mere fact of stabilization of prices 
could hardly be expected to eliminate crises. Since 1922 the price curve 
has been very nearly constant. Yet in 1929 we experienced another crisis. 


160 


THE EXPANSION OF ECONOMIC CONCEPTS 



Theories of Business Crises. —No economic problem has been of any 
greater concern to students of economic theory than has that of the busi¬ 
ness crisis. The early classical economists stood coldly by and cautioned 
patience until the natural laws could work out an automatic adjustment. 
The later neo-classical authorities attempted to find a solution in positive 
treatment in connection with the revised concept of economic laws. Persons 
less loyal to the "established order” have thought that the phenomenon came 
as a consequence of the automatic order and have looked for the remedy 
in some plan of overthrowing the established order and setting up a plan of 
conscious control in its place. Before proceeding with any observation of our 
own, let us examine various theories of the business crises as they have 
appeared from time to time. 

J. B. Say and the Theory of Unbalanced Vroduction. —The first theory 
in point of time since the appearance of business crises was at the same time 
one of the most satisfactory. We have already alluded to the excellent work 
done by J. B. Say in translating Adam Smith’s Wealth of Nations into 
French. Being a devotee of the automatic system and a decided believer in 
laissez-faire , naturally Say sought an explanation which would no do violence 
to the new order. Say, therefore, hastened to show that the fact that many 
goods suddenly became unsalable could not logically be attributed to over¬ 
production. General overproduction, he explained, was impossible. There 


































































































BUSINESS CRISES 


161 


certainly could not be too many goods when persons were cold and hungry. 
During the crisis more people are cold and hungry than at other times. Hence 
the effort to explain crises in terms of over-production was without founda¬ 
tion in logical analysis. 

Say therefore concluded that crises were due to unbalanced production. 
Persons who did not have the wherewithal with which to buy did not have 
it because they had not produced something different from that which other 
persons were busy producing. In other words everybody cannot make a living 
by taking in other persons’ laundry. Hence the fall in prices of things which 
were excessive would in time force persons out of the industries which 
had become overcrowded and into those which had too few persons engaged 
in them. The best remedy for an excessive production of any particular 
commodity was an excessive production of another equally as valuable. The 
more of each commodity and the greater variety of commodities and serv¬ 
ices the better the market. The more of each commodity and the smaller the 
variety the more likelihood of a crisis. 

Say, therefore, true to his philosophy of laissez-faire , did not look for a 
remedy in connection with any particular action on the part of the govern¬ 
ment. Man must find his own way out by concentrating his effort on those 
goods and services which had been neglected. 

Very few serious students of economics take issue with Say’s general 
thesis. Over-production is clearly impossible—or certainly unlikely. No one 
seriously questions the fact that if there could be a fully balanced production, 
goods would exchange freely and crises would not occur. Say’s thesis, there¬ 
fore, presents an excellent background against which to project any particu¬ 
lar analysis of business crises. As presented by Say, however, the theory 
carried little that is helpful in providing a remedy for business crises. Society 
has simply to bide its time till the natural laws can work themselves out. 
There may be some satisfaction in feeling that we understand why crises 
occur. But there is little in that to help us through the catastrophe. 

Sismondi and the Under-Consumption Thesis .—At the same time that 
Say was attempting to quiet the fears of those who contemplated the con¬ 
sequences of the new order the very order itself was being attacked by a 
great spirited prognosticator of social ills in such a way as to cause a search¬ 
ing of hearts for the next hundred years. Reference is to a certain Jean 
Charles de Sismondi, who also wrote in French. 

The points developed by Sismondi have become, consciously or uncon¬ 
sciously, the basis of practically every significant attack made on the so- 
called established order since his day. Some of these attacks have been theo¬ 
retically more skillfully worked out than that of Sismondi, but practically 
every one owes its inspiration to the same point of view as that advanced by 
Sismondi. 


162 


THE EXPANSION OF ECONOMIC CONCEPTS 


In a word, Sismondi’s thesis was that crises occur because of the fact that 
purchasing power does not keep pace with production. It does not automati¬ 
cally flow into the hands of the members of society whose demand is most 
significant in maintaining the equilibrium between production and con¬ 
sumption. Similar to the stand taken by Say, he sees an unbalanced produc¬ 
tion, but he does not find the crisis due solely to the fact of an unbalanced 
production. It is due rather to a shift in the consumer demand, which in 
turn is due to a piling up of purchasing power into the hands of the richer 
elements. This shift of purchasing power into the hands of the more pros¬ 
perous groups in society stimulates the market for the finer articles and 
luxuries. A shift of that kind concentrates productive effort on niceties and 
gives employment only to those employed there. Persons engaged in the pro¬ 
duction of necessities are, therefore, thrown out of employment. Not having 
jobs they do not have the purchasing power with which to buy the necessi¬ 
ties. The result is that shops are stocked with necessities and at the same time 
starving workers walk the streets without being able to become the cus¬ 
tomers of the shopkeepers whose trade they would supply if they could. Would- 
be customers suffer because of the shift of the purchasing power from those 
most in need of it. Crises are due, therefore, to the failure of wages to keep 
pace with the production. Wages do not rise fast enough to balance the 
results of production. Sismondi, therefore, is not enthusiastic over the con¬ 
sequences of the automatic system. He feels that society should look for a 
better system. 

A theory of the kind advanced by Sismondi, while very interesting, would 
be of little significance unless supported by an explanation of why the flow 
of money tended to be diverted from its most logical and most helpful trend. 
This Sismondi attempted to show was the natural consequence of the intro¬ 
duction of labor-saving devices. Hired men were forced out of employment 
by inventions which displaced them. The income from the improvements 
piled up in the hands of the "capitalists” because of the fact that capitalists 
owned the machines. He thought, therefore, if machinery should be intro¬ 
duced only when needed because of the shortage of labor instead of being 
adopted merely because it represented a saving in the labor bill, the harm¬ 
ful diversion of income would not occur and crises would not occur. 

We shall consider in another place the economic aspects of the introduc¬ 
tion of labor-saving devices (see p. 367). That involves a proposition sharply 
distinguished from the problem of business crises. The answer to the con¬ 
tention advanced by Sismondi, i. e., that business crises are due to under¬ 
consumption is in fact a very simple one. The best statistics show that money 
wages—in fact money wages corrected for purchasing power of money 
received—stand at a higher point in relation to the price trend just when 
the crisis occurs than they have stood at any previous period during the 


BUSINESS CRISES 


163 


interval of the decade preceding. This does not mean that when crises occur 
after a period of suddenly-rising prices during the price rise wages have risen 
faster than prices. In fact the reverse is true. Wages usually lag behind 
prices. But they are invariably higher just before the crash comes than they 
have been at any other time during the rise. This would seem to prove with¬ 
out question that the crisis is not due to the lag of purchasing power behind 
the output. When crises have occurred during a period of falling prices wages 
show a decided up-shoot. Professor Taussig, for instance, shows that in 
1893 the wage index stood at 160 when the price index stood at 90 (See 
chart on the next page). Since these things are so it is hard to see that busi¬ 
ness crises can be logically attributed to under-consumption. 

Sismondi’s Thesis Amplified. —No further treatment of the under-con¬ 
sumption theory would be necessary were it not for the fact that it has a way 
of continually reappearing. It has had no less than five outstanding recur¬ 
rences since the time of Sismondi. Each one of these is worthy of mention. 

(1) The Saint Simonian Thesis. —Just as Sismondi was the father of the 
under-consumption theory of business crises, likewise, and for a similar 
reason Saint Simon—particularly through his disciples—was the founder of 
the effort to abolish private property. There were other reasons why the Saint 
Simonians argued against the right of private property, but running through 
them all was the under-consumption theory of business crises. 

Writing in 1829, Bazard, one of the most prominent disciples of Saint 
Simon had the following to say: "Each individual devotes all his attention to 
his own immediate dependents. No general view of production is ever taken. 
There is no discernment and no exercise of foresight. Capital is wanting here 
and excessive there. This want of a broad view of the needs of consumers 
and of the resources of production is the cause of those industrial crises whose 
origin has given rise to so much fruitless speculation and so many errors 
which are still circulating in our midst. In this important branch of social 
activity, where so much disturbance and such frequent disorder manifests 
itself, we see the evil result of allowing the distribution of the instruments 
of production to be in the hands of isolated individuals who are at once 
ignorant of the demands of industry, of other men’s needs, and of the means 
that would satisfy them. This and nothing else is the cause of the evil.” 
(Quoted in Gide and Rist, p. 218.) 


164 


THE EXPANSION OF ECONOMIC CONCEPTS 



PROFESSOR TAUSSIG’S CHART, SHOWING THE COURSE OF WAGES AND PRICES 

OF COMMODITIES 

(' White’s Money and Banking , p. 124) 

The Saint Simonians were not so mild in their remedy as was Sismondi. 
They saw no hope of escape except in the abolition of private property. It 
should be noted, however, that their desire to abolish private property did 
not involve direct confiscation. They would simply deny the right of inheri¬ 
tance. In time, thus all property would revert to the state. Then the state 
could lease it on a basis of productive efficiency. Thereupon the "idle classes” 
would not stimulate, through their demand, productive effort at points which 
did not give employment to the great working classes. 

(2) Robert Owen’s Labor Coupon Thesis .—If not the most profound, 
certainly one of the most daring of the exponents of the under-consumption 
theory of business crises was the noted socialist, Robert Owen. He was an 
exceptional man in that he was at the same time a successful business man 
and an ardent socialist. Being a man of wealth he was prepared to support 
his theories in practical experiments. 

Robert Owen’s particular version of the under-consumption thory of 
business crises was that the whole trouble grew out of the fact of money. 
Money, he thought, came in to hinder rather than to facilitate exchanges. He 
accepted without question the labor theory of- value. Being a practical busi¬ 
ness man, he in effect said, if goods are to be valued in accordance with the 
amount of labor expended in their production any charge levied above that 
amounts to exploitation. Profits, therefore—the amount tacked on by mer- 



































BUSINESS CRISES 


165 


chants—were the source of all the trouble. The fact of profits was the cause 
of goods selling for more than they cost. The possibility of profits was due 
to the existence of money. 

"The existence of profit makes it impossible for the worker to purchase 
the product of his toil, arid consequently to consume the equivalent of what 
he produced. Immediately it is completed the product is snatched up by a 
superior body which makes it inaccessible either to the maker or to the men 
who could furnish an equivalent amount of labour or who could offer as the 
price of acquiring it a value equal to that labour.” (Gide and Rist, p. 239.) 

The solution was not far to seek. Root out the evil at its source. Abolish 
money and substitute for it labor coupons. Goods which cost so many hours 
of labor would command that many hours in labor coupons. In turn they 
would command other goods which had cost someone else the same number 
of hours of labor. Buying would then mean the exchange of equal values. 
Laborers would always have the wherewithal with which to purchase the 
products of other persons’ labor. Crises would be impossible for the simple 
reason that money could not pile up in the hands of the wealthy and thus 
divert the purchasing power from those who would otherwise buy the 
goods. 

The effort to reduce this plan to an actuality took form in the famous 
National Equitable Labour Exchange. We are told that Owen was not proud 
of his connection with that experiment. Yet it was a definite attempt to 
reduce the labor-coupon scheme to actual practice. "It took the form of a 
co-operative society with a central depot where each member of the society 
could deposit the product of his labour and draw the price of it in labour 
notes, the price depending upon the number of hours of work the product 
had cost, which number the member himself was allowed to state. These 
products, or goods as they were now called, marked with a figure which indi¬ 
cated the number of hours they had taken to produce, were at the disposal 
of any member of the exchange who wished to buy them. All that a mem¬ 
ber had to do was to pay the ticketed price in labour notes. And every worker 
who had taken, say, ten hours to make a pair of stockings was certain of 
being able to buy any other article which had also cost ten hours.” (Gide 
and Rist, p. 241.) For cuts of these labor notes see Norman Angell’s Story 
of Money, p. 46. 

Since the experience with the National Equitable Labour Exchange fur¬ 
nishes a good exercise in connection with accurate analysis of market value 
the following account of Exchange is given in detail: 

“The Labour Exchange, which opened in September, 1832, at first enjoyed a slight 
measure of success. There were 840 members, and they even went the length of establishmg a 
few branches. Among the chief causes of the failure of the scheme the following may be 
enumerated: 

“(a) The associates, being themselves allowed to state the value of their products, 
naturally exaggerated, and it became necessary to relieve them of a task which depended 


166 


THE EXPANSION OF ECONOMIC CONCEPTS 


entirely upon their honour, and to place the valuation in the hands of experts. But these 
experts, who were not at all versed in Owen’s philosophy, valued the goods in money in the 
ordinary way, and then expressed these values in labour notes at the rate of 6d for every hour 
of work. It could hardly have been done on any other plan. But it was none the less true 
that Owen’s system was in this way inverted, for instead of the labour standard determining 
the selling value of the product, the money value of the product determined the value of 
the labour. 

" (b) As soon as the society began to attract members who were not as conscientious as 
those who first joined it, the Exchange was flooded with goods that were really unsaleable. But 
for the notes received in exchange for these the authorities would be forced to give goods 
which possessed a real value, that is, goods which had been honestly marked, and which com¬ 
manded a good price, with the result that in the long run there would be nothing left in 
the depot except worthless products. In short, the Exchange would be reduced to buying goods 
which cost more than they were worth, and selling goods that really cost less than they 
were worth. 

(c) "Since the notes were not in any way registered, any one, whether a member of the 
society or not, could buy or sell them in the ordinary way and make a handsome profit out of 
the transaction. Three hundred London tradesmen did this by ’offering to take labour notes 
in payment for merchandise. They soon emptied the exchange, and when they saw nothing 
valuable left they stopped* taking the notes, and the trick was done.”—Gide and Rist, p. 
242, note. 

(3) Karl Rodbertus and Industrial Planning Through the Government. 
The current swing toward some kind of a supreme economic council to sub¬ 
stitute a conscious plan of control of industrial output for the automatic 
system smacks strongly of Rodbertus. Even where they have run to extremes 
in the direction of socialism, although done in the name of Karl Marx, their 
plan of action conforms much more closely to Rodbertus’ philosophy than 
it does to that of Marx. This fact will be apparent as we proceed. Rodbertus 
did not attempt to attribute business crises to any particular aspect of the 
economic order but instead to the whole phenomenon of the automatic sys¬ 
tem of adjustment of supply and demand. 

"Should society be allowed to work out these projects spontaneously, or 
should it endeavour to carry out a preconceived plan? To Rodbertus this was 
the great problem which society had to consider. The economists of Smith’s 
school treated the social organism as a living thing. The free play of natural 
laws must have the same beneficial effects upon it as the free circulation of 
the blood has upon the human body. Every social function would be regu¬ 
larly discharged provided 'liberty’ only was secured. Rodebertus thought this 
was a mistake. 'No State’, says he, 'is sufficiently lucky or perhaps unfortu¬ 
nate enough to have the natural needs of the community satisfied by natural 
law without any conscious effort on the part of anyone. The State is an his¬ 
torical organism, and the particular kind of organization which it possesses 
must be determined for it by the members of the State itself. Each State 
must pass its own laws and develop its own organization. The organs of the 
State do not grow up spontaneously. They must be fostered, strengthened, 
and controlled by the State! Hence, after 1837 we find Rodbertus propos- 
ing the substitution of a system of State direction for the system of natural 
liberty, and his whole work is an attempt to justify the introduction of such 
a system.” (Gide and Rist, p. 418-19.) 


BUSINESS CRISES 


167 


It is an interesting fact that Rodbertus did not deny that intrepreneurs 
were essential to production. His denial related only to their right to com¬ 
pensation as entrepreneurs. In this respect Rodbertus was superior as an econo¬ 
mist to Karl Marx. He thought that business ability exists in such large quanti¬ 
ties that no compensation was necessary in order for society to secure the 
benefit of the services of entrepreneurs. He, therefore, placed entrepreneurs, 
capitalists, and landowners in the same class insofar as their social status 
related to the social income. "The capitalistic producer of today manages his 
business in accordance with the dictates of personal interest, and personal 
interest compels him to apply his instruments to produce whatever will yield 
him the largest net product. He is more concerned about the amount of profit 
made than about the amount of produce raised. He produces, not with a view 
to satisfying any social need, but simply because it yields him rent or profit.” 

The prime cause of the discrepancy, according to Rodbertus, was the 
fact that production always tends to adapt itself to effective demand, i. e., 
demand expressed in terms of money. "Only those people who already possess 
something can have their wants satisfied. Those who have nothing to offer 
except their labour, and find that there is no demand for that labour, have 
no share in the social product. On the other hand, the individual who draws 
an income, even though he never did any work for it, is able to make effec¬ 
tive his demand for the objects of his desire. The result is that many of the 
more necessitous persons must needs go unsatisfied, while others wallow in 
luxury.” (Gide and Rist, p. 419.) 

And to cap the climax, "the entrepreneur keeps adding to the mass of 
commodities produced until he touches the full capacity of social demand. 
But while production grows and expands the workers’ share dwindles, and 
thus his demand for some products remains permanently below production 
level. The structure is giving way under the very feet of the unsuspecting 
producer.” (Gide and Rist, p. 426.) 

We are told that Rodbertus’ lifelong hope was to be able to give a statis¬ 
tical proof of his thesis. That, of course, he never did. But he proceeded to 
construct a plan of amelioration very much as if he had proved his thesis. 
The crux of his whole scheme was to substitute a conscious plan of adap¬ 
tation of production to social needs for the haphazard system of adaptation 
to effective demand. He would have established a statistical bureau which 
would first tabulate the social needs. Having once accurately measured the 
social needs the problem of adjustment of productive agencies so as to bring 
into existence exactly the correct amounts of the different articles of human 
desire would be a simple one. Rodbertus, however, desired to go further 
than that. He would, much as did Robert Owen—but in a different way— 
substitute a system of labor coupons for the present money. Each enter¬ 
priser was to be given by the state a number of coupons in accordance with 


168 


THE EXPANSION OF ECONOMIC CONCEPTS 


the number of workers he employed. In return for the coupons the business 
man would be required to put on the market quantities of commodities equal 
in value. The workers would be paid in coupons. Since labor alone, according 
to Rodbertus, is worthy of receiving compensation for services performed, 
all of the coupons would be paid out by the enterprisers in the form of wages. 
The consuming power—buyer power—would of necessity be exactly equal 
to the productive output. That being so, there could be no maladjustment 
between consumption and production. Thus crises would be made impossible. 

It takes but a small comprehension of the actual behavior of economic 
forces to see the major defects in Rodbertus’ scheme. It should be noted, 
however, that there is very little, if anything, wrong with Rodbertus’ criti¬ 
cism of the automatic system. The very fact of business crises is enough 
evidence of that. However, pointing out defects in a system and providing a 
remedy are two entirely different things. If the suggested remedy is worse 
than the disease we had better endure the disease. 

The fundamental error in Rodbertus’ scheme is the assumption that it 
is possible to make a tabulation of social needs. Any scale of needs that 
might be tabulated must of necessity be an arbitrary one. The one type of 
goods that all would agree is a need—that of food—would itself cause 
endless bickering. As for commodities serving the less essential wants the 
problem would be greatly increased. An order of the kind is unthinkable 
except through some kind of an autocracy. Even then an autocracy plus a 
system of rationing could hardly do less than sap the very life out of the 
denizens. More than that hardly needs to be said. 

(4) Current Revivals of the Under-Consumption Thesis. —So frequent 
are restatements of the Sismondi hypothesis in our own time that one can 
only wonder at the lack of familiarity with the history of the concept of 
economic crises among persons who it would appear should know better. The 
two that are receiving the widest attention are those of J. A. Hobson, an 
English authority, and William Trufant Foster, an American. Little differ¬ 
ence exists between the general statement of the under-consumption hypo¬ 
thesis by these authorities and those already indicated. The main difference 
lies in the suggested remedies. In fact most of the modern authorities show 
a somewhat inferior comprehension of the general relation between produc¬ 
tion and consumption than did Sismondi. 

The Foster thesis appeared in several books published under the joint 
authorship of Foster and Catchings. Probably the best of the books for the 
purpose of elucidation of their general proposition is their book called Profits. 
Their well-known contention has been widely circulated in the following 
language: 



BUSINESS CRISES 


169 


' Progress toward greater production is retarded because consumer buying does not keep 
pace with production. Consumer buying lags behind for two reasons; first, because industry 
does not disburse to consumers enough money to buy the goods produced; second, be¬ 
cause consumers, under the necessity of saving, cannot spend even as much money as they 
receive. There is not an even flow of money from producer to consumer, and from consumer 
back to producer. The expansion of the volume of money does not fully make up for the 
deficit, for money is expanded mainly to facilitate the production of goods, and goods must 
be sold to consumers for more money than the expansion has provided. Furthermore, the 
savings of corporations and individuals are not used to purchase the goods already in the 
market, but to bring about the production of more goods. Under the established system, there¬ 
fore, we make progress only while we are filling our shelves with goods which must either 
remain on the shelves as stock in trade or be sold at a loss, and while we are building more 
industrial equipment than we can use. Inadequacy of consumer demand is, therefore, the main 
reason why we do not long continue to produce the wealth which natural resources, capital 
facilities, improvements in the arts, and self-interest of employers and employees would other¬ 
wise enable us to produce. Chiefly because of the shortage of consumer demand, both capital 
and labour restrict output, and nations engage in those struggles for outside markets and 
spheres of commercial influence which are the chief cause of war.” 

From this we can see that Foster and Catchings’ analysis is somewhat less accurate than 
that of Sismondi. It never seems to occur to them that producers and consumers are the same 
people. The assumption of a sharp dividing line between them is highly confusing. Sismondi, 
who is at best not considered much of a scientist, avoids that error when he says that un¬ 
balanced production concentrates the demand on more refined articles in place of ordinary 
things of life, the glut thus caused by the displacing of demand for ordinary things by the 
demand for refined articles being the moving cause of crises. According to Sismondi, there¬ 
fore, the crisis is not the result of the failure of consumer demand to keep pace with production 
. but rather the shift in consumer demand which causes widespread unemployment, and this in 
turn causes a shortage of funds with which to buy even the ordinary commodities until there 
has been a new price alignment. As is readily seen, the Sismondi proposition is much less 
subject to criticism. 

Again, Foster and Catchings, although they comprehend fully the function of money as 
a medium of exchange—in fact they are intoxicated with that concept—yet they lose sight 
of the other functions of money. Especially is that so with regard to money as a standard of 
value and as a store of value. Practically no recognition is apparent of the distinction between 
money and capital. The distinction between the individual and the social concept of money is 
never clearly recognized. 

The further inaccuracy of the Foster and Catchings thesis, that contained in their attack 
on saving, will receive treatment in a later discussion. 

Foster and Catchings desire the government to take action hardly less 
ambitious than that suggested by Rodbertus. The government would prob¬ 
ably not go as far as to assume the direction of all productive activities. 
But they would have a commission appointed to set into motion forces which 
are supposed to bring about a more ready adjustment of production to con¬ 
sumption. Their commission would operate for the business world much as 
the weather bureau operates today in relation to the weather. The commis¬ 
sion would give warnings to those whose actions are likely to be disastrous. 
There is really a short step from that to actually directing the conduct 
of business men. 

Hobson, in his treatment of the under-consumption thesis, takes little 
notice of the "circuit flow of money”. He is satisfied, however, that if the 
money did flow readily back to the laborers business crises would not occur. 

Hobson sees little hope in any single positive act either on the part of 
the government or of the suffering masses. Fie does suggest, however, that 
something can be done by society as a whole to make amends. He suggests 


170 


THE EXPANSION OF ECONOMIC CONCEPTS 


that "all of those factors in modern life which tend to equalize the possession 
of wealth should be fostered. All those tendencies which accentuate the dis¬ 
parities between the rich and the poor should be discouraged. In this way, 
buying capacity would increase and a proper proportion between spending 
and saving would be maintained. Thus reforms in taxation making the 
burden fall upon those who are best able to bear it, the organized labor 
movement and labor legislation which prevents exploitation of labor and 
increases wages, the limitation on the monopoly of natural resources, and 
the government control of public utilities, are factors working toward those 
equalizations.” (Blum: Labor Economics, p. 231.) 

Professional Economists’ Analyses of Business Crises. —It is only 
within the last fifty years that professional economists have attempted con¬ 
structive analyses of business crises. That was to be expected since the greater 
part of the nineteenth century was characteristically laissez-faire in the atti¬ 
tude of economists toward business. Hence whatever reference was made in 
treatises on economic theory toward business crises was little more than a 
restatement of the philosophy of J. B. Say. The work of the economists 
proper, however, falls clearly into two divisions, each of which subdivides. 

(1) Deductive Analyses. —The pace for the deductive economists was 
set by J. S. Mill. The following quotation is representative of Mill’s treat¬ 
ment of the subject: 

"I have already described the state of the markets for commodities 
which accompanies what is termed a commercial crisis. At such times there 
is really an excess of all commodities above the money demand; in other 
words, there is an under-supply of money. From the sudden annihilation of 
a great mass of credit, everyone dislikes to part with ready money, and 
many are anxious to procure it at any sacrifice. Almost everybody therefore 
is a seller, and there are scarcely any buyers; so that there may really be, 
though only while the crisis lasts, an extreme depression of general prices, 
from what may be indiscriminately called a glut of commodities or dearth 
of money. But it is a great error to suppose, with Sismondi, that a commer¬ 
cial crisis is the effect of a general excess of production. It is simply the 
consequence of an excess of speculative purchases. It is not a gradual advent 
of low prices, but a sudden recoil from extravagantly high: its immediate 
cause is a contraction of credit, and the remedy is, not a diminution of sup¬ 
ply, but the restoration of confidence. It is also evident that this temporary 
derangement of markets is an evil only because it is temporary. The fall 
being solely of money prices, if prices did not rise again no dealer would lose, 
since the smaller price would be worth as much to him as the larger price 
was before. In no manner does this phenomenon answer to the description 
which the celebrated economists have given the evil of over-production. That 


BUSINESS CRISES 


171 


permanent decline in the circumstances of producers, for want of markets, 
which those writers contemplate, is a conception to which the nature of a 
commercial crisis gives no support.” (Vol. II, Book III, Chapter XIV, 
Sec. 4.) 

In the neo-classical economic philosophy, along with other classical eco¬ 
nomic concepts, that of the commercial crisis came in for a revision. It came 
with the appearance of the well-known Austrian school of economists and 
their disciples. These, as is true in other particulars, are marked by two off¬ 
shoots—the Psychological and the Mathematical. The Psychological branch 
of the Neo-Classicals present at least three well-defined explanations of crises. 
A summary of these will now be given. 

The Pigou Thesis .—Probably the most nearly classical of all of the neo¬ 
classical explanations is that presented by Prof. A. C. Pigou, a disciple of Dr. 
Alfred Marshall. Pigou explains the crisis by the fact of disparity between the 
marginal wage and the commercial wage. At a later point we shall explain 
more fully the expression marginal wage. Suffice it to say at this time that "It 
is theoretically possible,” he says, "that wage rates at any moment and in every 
part of the industrial field can be so adjusted to the demand for labour of 
various grades that no unemployment whatever can exist. In other words . . . 
unemployment is wholly caused by maladjustment between wage rates and 
demand! At any given time all the labor in a community could be employed 
at some price. A static society need only find the price of labor that would 
result in a commodity price sufficient to move the goods produced, and 
avoid artificially high wages due to group action or national minimum stand¬ 
ards. It follows that there cannot be a permanent glut. Under actual condi¬ 
tions, fluctuations in demand for labor occur through individual trade varia¬ 
tions, seasonal fluctuations, and the industrial cycle. The industrial cycle 
occurs through variations in the bounty of nature and in the confidence of 
investors, both of which affect the amount of the wage fund available. These 
fluctuations are primarily felt in the production of instrumental goods, 
since they are naturally more sensitive to changes in investment. Adjustment 
of wage rates to these types of fluctuations of demand are impeded by the 
rigidity of wage rates and immobility of labor, and thus unemployment 
comes about.” (Blum: Labor Economics, p. 223.) 

It would seem, therefore, that Pigou places the blame for crises largely 
on the laborers. Their continual, and to no small extent successful, efforts 
at boosting their wages made through their organizations and otherwise press 
the commercial wage out of line with the economic wage. Business men 
finding it impossible to pay the wages demanded, and in some instances con¬ 
ceded, have to close shop. This‘closing of the enterprises throws the men on 
the streets. As long as the commercial wage stands at that relatively high 


172 


THE EXPANSION OF ECONOMIC CONCEPTS 


level the distress prevails. This is, to say the least, an interesting contrast to 
the under-consumption hypothesis. 

The Beveridge Thesis .—Not very sharply differentiated from the Pigou 
thesis is that of W. H. Beveridge, set out in his Unemployment , a Problem 
of Industry. According to him "the problem to be analyzed ... is that of 
maladjustment between the supply of and demand for labor, in other words 
the disorganization of the labor market. The supply of labor grows steadily, 
but, though the average growth of demand is equivalent, its actual growth 
is rendered unequal and uncertain by the industrial fluctuations of the busi¬ 
ness cycle. Still further maladjustments, and more important, are those due 
to the labor reserve which collects at each center of the labor market, 
whether these centers be single employers or local industries, and tends to 
equal the maximum number who may be able to find employment there. 
Variations in the volume of business and casual methods of engaging workers 
will create a permanent condition of under-employment, distributed among 
the various members in its extreme form will result in a stagnant pool of 
labor whose earnings are below or barely equal to subsistence. The remedy 
is to be found in an 'organized and intelligent fluidity’ of labor, to be 
achieved through the organization of the labor market; the existence of 
labor exchanges to properly direct the market; the decasualization of hiring, 
which will limit the extent of under-employment; the amalgamation of 
centers of demand so that, instead of each employer’s maintaining a reserve 
for the fluctuations in his particular plant, the reserve will be for the entire 
industry and the individual variations of demand will to some extent cancel 
each other and thus reduce the size of the necessary reserve. The minimal 
reserve to meet the fluctuations of the industry is necessary and desirable, 
or at least inevitable, so long as industrial fluctuations persist in society.” 
(Blum’s Labor Economics, 226.) 

We are told that the Beveridge attack prompted the widespread develop¬ 
ment of labor exchanges and unemployment insurance in England. Although 
the results secured are certainly worth the cost, they have also shown that 
the problem lay deeper than merely provision of a plan to adjust supply of 
labor to demand. Periods of overwhelming numbers of the unemployed 
swamping the employment agencies call for a more searching analysis of the 
problem. 

The Over-Capitalization Thesis .—Coordinate with the theories developed 
by Pigou and Beveridge is the over-capitalization thesis, which has had wide 
acceptance. This has been summarized as follows: 

"Economists, therefore, are in general 4 agreement nowadays on a third 
explanation. They find the cause of crises in over-capitalization rather than 


BUSINESS CRISES 


173 


in over-production. Although this theory itself takes many different forms, 
the following are its commonest features. 

"If industry had only to adapt production to wants from day t© day, it 
would be easy enough. Even if it did not exactly succeed, a crisis would not 
not be the result, any more than a crisis occurs when a pastry-cook finds him¬ 
self with a surplus of cakes at the end of the day, through having misjudged 
the wants of his customers. But large-scale industry cannot be content with 
day-to-day production; it must anticipate wants, and in order to be able to 
meet them, it must create a long time beforehand all the necessary means of 
manufacture and transport, such as factories, machinery, mines, trucks, 
ships, etc.—and that takes time. Meanwhile people’s wants increase, people 
grow impatient, and prices rise. Then when the means of production are at 
last ready to come into action, they suddenly pour out floods of products on 
the market. Observe, too, that these floods cannot now be stopped at will, for 
when capital has once been invested as fixed capital it can no longer be set 
free; it has to continue working even when the market has become saturated, 
and even when it is working at a loss. It will easily be understood, therefore, 
why the fall in prices may end in a complete collapse. It will not encl until 
a certain number of new businesses have become bankrupt or have given up 
the struggle, or until the fall in prices has had its usual effect of increasing 
consumption, so that the excess is gradually absorbed. 

"It can be understood, also, why crises are separated by fairly regular 
intervals. The length of these periods is just that which is necessary for 
fresh building-up of the capital destroyed by the crisis. And this theory per¬ 
fectly explains, too, why crises are phenomena that accompany the capitalist 
system, and more especially the system of large-scale industry. 

"Moreover, we can understand better now why even those who are not 
engaged in business—people of independent means and the general public— 
are actors in the crisis, helping to precipitate it, and bearing the consequences. 
What, in point of fact, do we see on these occasions? Here a period of pros¬ 
perity: harvests are good, there is no fear of war, industry progresses, every¬ 
thing goes well. Then we see the prices of all shares go up—copper mines, 
coal mines, rubber shares, banks, railways. Every small shareholder turns over 
his bill-case and asks those whom he thinks well informed: 'Tell me what is 
going to rise’. He runs little risk of going wrong, for everything rises. 
Everywhere new businesses are exploited, . . . and even old-established busi¬ 
nesses increase their capital by fresh issues of stock. 

"Then comes the day when all these businesses begin to compete with 
each other. An ominous crash occurs: one of them has gone under. Immedi¬ 
ately there is a panic and just as, not long before, the more prices rose the 
more eager were the buyers, so now, the more they fall the more eager are 
the holders to sell. There are few capitalists who manage to get out in time, 


174 


THE EXPANSION OF ECONOMIC CONCEPTS 


as it is called. By degrees all those securities that represented so much antici¬ 
pated income and the ‘capitalization of so many hopes/ as M. Seligman elo¬ 
quently says, sink down, even before it can be known whether overproduc¬ 
tion has really taken place.” (Gide: Principles of Political Economy, 13 5-6.) 

The remedy suggested by Prof. Gide, if over-capitalization be accepted as 
the correct explanation, is to be found in more careful handling of credit 
agencies. 

Professor Gide, however, hastens to add: “If this last explanation is the 
true one, however, the remedy is more doubtful, for the evil is more psycho¬ 
logical than economic. It is rather a question of education, a case for teaching 
the public not to believe that because a share goes up they must buy it, and 
that because it goes down they must sell it. This lesson teaches itself, in the 
sense that a bad sale, a fall in prices, the difficulty of procuring money, and 
spectacle of failures, by frightening producers, cannot fail to check overpro¬ 
duction. Only, this remedy ceases to act as soon as the chilling effects of the 
shower-bath has ceased. Perhaps the most efficacious remedy would simply be 
a knowledge of crises sufficiently accurate to enable one to predict definitely 
their recurrence. For it is permissible to believe that a crisis foreseen and to 
some extent discounted, would thereby be either averted or at least weakened. 
Yet we must not trust to that, for it often happens that the fear of an evil 
has the precise effect of producing that evil! The Great War might probably 
have been avoided if everyone had not foolishly said that it was inevitable.” 
(Principles of Political Eoconomy, pp. 137-8.) 

The Mathematical Thesis .—No students have written with greater assur¬ 
ance on the nature of and remedy for business crises than the mathematical 
economists. With the exception of Jevons—probably the most brilliant of 
all of the Mathematical—they have done little more than take the state¬ 
ments made by J. S. Mill—that crises are but a sudden fault in price pro¬ 
cesses—and reduced them to exactitude. The value of all commodities can fall 
only if money has any equivalent rise; therefore an automatic adjustment 
of money and its equivalents so as to prevent its change in value would of 
necessity eliminate the very possibility of business crises. If prices as a whole 
are not allowed to rise they cannot fall. 

The proof of the above proposition by deductive mathematical analysis 
is very interesting. No recent author has treated the subject with greater 
skill than has Professor Irving Fisher, of Yale University. His well-known 
propaganda for the compensated dollar deserves very close study. 

The compensated dollar proposition means a determination, on the part of 
the government, to provide a constant measure of value much as has already 
been done for other measures. Professor Fisher states that it is as illogical to 
have the measure of value to change with the value of gold as it is to have 


BUSINESS CRISES 


175 


the measure of length to change with the size of the king’s foot. Originally 
portions of the human body were employed to measure length. That explains 
many of the familiar terms now employed for that purpose. Long ago the 
government has taken a positive control of that kind of measure. All that 
these terms now mean is a definite and arbitrarily determined length or 
quantity kept under the surveillance of the government. If any question is 
raised as to the accuracy of any transaction involving any of these amounts 
it is always possible to verify the accuracy by comparison with standards 
kept by the government. No such a possibility exists with regard to the meas¬ 
ure of value. Professor Fisher offers the "compensated” dollar device as an 
equivalent arrangement for the measure of value. 

To this end he would have the dollar stand for so much purchasing 
power instead of so many grains of gold. Beginning at some opportune time 
the government would set up a statistical bureau whose function would be 
to keep scientifically accurate index numbers so as to measure the variations 
in the purchasing power of money. If prices tended to go up, the dollar would 
be compensated by enough gold to offset its fall in value. Similarly for any 
decline in purchasing power. A dollar would thereafter mean a certain and 
constant purchasing power and a varying amount of gold instead of a con¬ 
stant weight in gold and a varying purchasing power. Needless to say the 
coinage of gold would cease. The exchange transactions would be carried on 
by means of paper and token money much as is the case now. The only 
difference would be that a ten dollar bill, say, would not always command at 
the mints exactly the same number of grains of gold. 

A few obstinate facts interfere with the acceptance of the compensated 
dollar proposition. Not the least of them is the fact that many other forces 
interfere with the purchasing power of money than that of gold production. 
It is doubtful that the mere determination on the part of the government 
to modify the amount of gold in the dollar to conform to its change in pur¬ 
chasing power would go very far in the direction of stabilizing the value of 
the dollar. That fact becomes evident from an examination of the chart a 
few pages back (p. 160). It is seen that there is in fact a very little corre¬ 
lation between the gold supply and the price level. 

Owing to the difficulties in the way of the operation of the compensated 
dollar project, it has been widely suggested that the purchasing power of 
money can be stabilized by acting on the circulation through a plan of 
regulation of credit. In this regard the over-capitalization thesis and the 
mathematical thesis are very similar. 

We are informed that certain central banking institutions are already, to 
a large extent, following this plan. As a result during the last decade 
(1920-30) the price level has remained surprisingly nearly constant. 

The principle of the control of crises through the control of credits may 


176 


THE EXPANSION OF ECONOMIC CONCEPTS 


be briefly stated as follows: Funds may be thought of as flowing out of banks 
through the valve of loan and discounts. They may be thought of as flowing 
back into the banks through the valve of encashment. That is to say, when 
the banks are lending they are discharging their funds through the outflow. 
When the loans are paid the funds flow back to the bank. Now, the ideal 
condition would be to have the outflow exactly equal to the intake. Assum¬ 
ing that, in one way or another, the bulk of the funds of the country are 
handled by the banks, and assuming that the banks of the country are well 
coordinated, then if the two streams can be kept approximately equal, prices 
must remain very nearly constant. The control of prices through the con¬ 
trol of the credits undertakes arbitrarily to keep these streams approxi¬ 
mately equal in size. 

The barometer of the situation is the bank reserve—usually gold. If the 
loan and discount stream for any reason increases without a corresponding 
increase in the size of the reserve, naturally the ratio of reserves to credit will 
fall. The barometer registers an approaching crisis. Prices are likely to be in 
the upward swing. As long as there is not a positive check to the expansion 
of loans other than the legal reserve ratio, nothing can be done to stop the 
rising price trend until the legal limit is approached. At that time the banks 
begin to call a halt by closing the valve of loan and discounts and opening 
the valve of encashment. That is done by either refusing to renew notes 
when they fall due or by renewing them under more rigid terms. Let us sup¬ 
pose that a person has borrowed from a bank on warehouse receipts based 
on, say, sugar. He may be holding the sugar for a rise in price, holding it by 
means of the loan at the bank. Now, when he finds the bank unwilling to 
renew the note he is forced to throw the sugar on the market in order to raise 
the cash with which to pay the note. Others being impelled to resort to the 
same tactics with regard to their loans the market suddenly becomes flooded 
with goods which shortly were held as security for loans at the banks. Prices, 
of course, fall precipitately. A crisis is on. 

Now, the theory of credit control is that a central agency, much as we 
have in our Federal Reserve Banking system, can take the situation by the 
forelock and arbitrarily prevent the expansion and contraction of credit in 
response to an arbitrarily controlled discount rate. By giving attention to skill- 
fully-kept index numbers the reserve board can take action to stop a rise in 
prices as soon as it becomes apparent. When the index numbers show a ten¬ 
dency for prices to rise let the board adjust the discount rate upward so as to 
make loans—credits—harder to get. Let them tighten up the valve of loans 
and discounts. Shortage of funds would cause an increase in the value of money 
and offset the rise in prices. The reverse action is to be taken when the index 
numbers show a tendency for prices to go down. In order to enable the board 
to make their rate effective they are given the right to engage in open market 


BUSINESS CRISES 


177 


transactions. That is, if dealers in money outside of the banks attempt to cut 
under the bank rate when there has been an adjustment upward, the banks 
can buy as much of the paper as is necessary to bring the market rate in line 
with the bank rate. In case the open market rate is for any reason higher 
than the bank rate the banks are authorized to sell paper until the market 
rate is in line with the bank rate. Assuming the organized banking institu¬ 
tions have enough funds and securities at their command to dominate the 
market—and as a rule that is true—they are an effective agency of price 
stabilization. A definite evidence of that power has been seen during the last 
eight or ten years. 

It should be further noted that the controlling agency can use its power 
to other ends than that merely of price stabilization. When they face the 
problem of expansion or contraction of loans, they can use their discretion 
with regard to what types of loans will be given most consideration. By 
that means they can to no small extent influence the investment of funds. 
If crises are due to over-capitalization they are in a very powerful position 
to use pressure to prevent undue expansion of certain businesses which bear 
evidence of being overdone, and in lending encouragement as well as credit 
to those enterprises which are engaged in work which is more essential. It is 
hardly to be expected that the banking institutions can ever have the vision 
and foresight to cover the whole field of business. Their influence in that 
direction, however, can certainly be helpful. 

What are we to say, however, with regard to price stabilization as a 
solution to the problem of business crises? If crises were due, as is widely 
asserted, merely to the fact of price slumps then the solution would be at 
hand. We have seen, however, that crises occur as certainly in a period of 
falling prices as in one of rising prices. The crisis of 1929 shows that they 
may also occur even when prices are very nearly constant. There is little 
question that the policy of stabilization of prices through the control of 
credits is an entirely wholesome innovation. Yet from the evidences before 
us we are forced to conclude that the phenomenon of business crises is not 
necessarily associated with price changes. We must, therefore, look further 
for a plausible explanation of business crises. 

(2) The Inductive Approach to the Problem of Business Crises. 
—Up to this point we have been considering only those theories of business 
crises developed by the deductive conomists. Not a little work has been done, 
however, from the inductive point of view. The most illuminating exponents 
of this point of view are our own Professor W. C. Mitchell and the Swedish 
economist, Dr. Gustav Cassel. We have already seen that the widespread 
use of the term business cycle instead of business crisis is largely due to 


178 


THE EXPANSION OF ECONOMIC CONCEPTS 


the work of the former. Strange as it may seem, Dr. Cassel has not seen 
fit to adopt Professor Mitchell’s term. 

The Marxian Thesis .—If Karl Marx can be said to have employed any 
scientific method at all it was inductive. His whole system is based on his¬ 
torical synthesis. In so far as he presents any interpretative data at all they 
are presented in the light of observation of historical phenomena. In the 
light of what he finds having taken place and now taking place before his 
own eyes he draws his conclusions. 

The Marxian thesis has awakened a tremendous aggressiveness among 
crusaders for social betterment. This has been done in spite of the fact that 
Marx himself did not sponsor directly any effort to topple over the established 
order. It is true that in his Communist Manifesto he called on the pro¬ 
letariate to form into a party for the purpose of looking out for their own 
interests. But the prime impulse of the Marxian thesis is that the present 
order contains elements that in the end will encompass its own downfall. 
His urge, therefore, was rather to prepare the minds of the workers every¬ 
where for an eventuality which they must face. That eventuality grew out 
of his theory of social or economic crises. Hence the Marxian theory of 
economic crises is the kernel of his whole system. 

His theory of crises is so tied into his whole doctrine of socialism that 
it is necessary to get it all to understand a part of it. Fortunately the 
philosophy is comparatively simple. That fact is possibly as much responsible 
as any other one fact for the great development that Marxian socialism 
has had. 

The foundation of the whole system is his theory of surplus value. As is 
true of so many socialist concepts, that theory is based on a concept developed 
by Sismondi. It is nevertheless a limb grafted on the Ricardian economic 
theory of value. It will be remembered that the Ricardian theory of value is 
the labor theory. It is that fundamentally the value of all goods is determined 
by the amount of labor expended in their production. Now, Marx never 
questioned the accuracy of that assumption. Instead he proceeded to show 
that the established order so operated that much of this value did not go to 
those who were responsible for its existence. This was shown to be the 
result of what he called the surplus value phenomenon. 

The surplus value was explained as the difference between the amount 
that the product would bring on the market and the amount expended by 
the capitalist in its production. Since goods invariably tended to sell for more 
than they cost, the capitalist is invariably absorbing values which should 
logically belong to the laborers. It should be remembered that Marx did 
not have the concept of the entrepreneur. The term capitalist meant to him 
the owners of big industrial plants. 


BUSINESS CRISES 


179 


Owing to the fact that the capitalists are all the time swelling their 
fortunes through the exploitation of labor, the laborers are increasingly 
finding it harder and harder to make ends meet. This fact is responsible 
for the fact that goods frequently go without buyers. Capitalists are con¬ 
sciously enlarging their plants, requiring longer hours, employing fewer men, 
and doing everything in their power to swell the surplus value. At certain 
intervals, as a consequence, occur crises. Each crisis means the disappearance 
of many capitalists from the ranks of capitalists. These go to swell the ranks 
of labor. With each crisis the rich men become fewer and richer. In time 
the poor will become so poor and so numerous and the rich so few that the 
poor will rise in their might and seize the industries. At that time would be 
ushered in collective ownership and operation of the industries. Then the 
workers will come to their own. Thereafter the surplus value will disappear 
and with it the phenomenon of economic crises. The laborers will all get 
their due. 

With the refutation of the labor theory of value the Marxian thesis lost 
any foundation on which it may seem to have rested. With the development 
of the entrepreneur concept, the theory of exploitation lost its significance 
if it ever had any. Now students come and show that it cannot be demon¬ 
strated that the rich are getting richer and fewer and the poor poorer and 
more numerous. The fact is that none of the fundamental bases upon which 
Marxian socialism rests are acceptable. Anything else that may appear at¬ 
tractive in his theory has been shown not to be able to stand the test of 
careful analysis. Again, the whole Marxian system is the least satisfactory 
and the least scientific of all of the theories of business crises. It seems fair 
to laborers. It is therefore capable of widespread acceptance by the great 
masses when presented by demagogues and spell-binders generally. Because 
of that fact possibly more than any other the Marxian thesis has had a wider 
sway than any of the other theories of economic crises. Fortunately for the 
race, however, there have been enough men of poise in the high places to tip 
the scales against excesses which might otherwise have resulted from the 
widespread acceptance of Marxian teachings. 

The Mitchell Thesis .—The contribution of Dr. Mitchell appears in his 
famous treatise on "Business Cycles.” In this work he speaks cautiously as 
follows: "The deepest seated difficulty in the way of framing such a theory 
arises from the fact that while business cycles recur decade after decade each 
new cycle presents points of novelty. Business history repeats itself, but 
always with a difference. This is precisely what is implied by saying that the 
process of economic activity within which business cycles occur is a process 
of cumulative change. 

"It follows that a thoroughly adequate theory of business cycles, ap¬ 
plicable to all cases, is unattainable. Even if some one cycle could be fully 


180 


THE EXPANSION OF ECONOMIC CONCEPTS 


accounted for, the account would necessarily be inaccurate with reference 
to cycles which were the outgrowth of earlier or later conditions. Nor are 
all the differences between the successive cycles of one country and between 
the contemporary cycles of several countries differences in minor detail. 
Even such an elementary matter as the order in which the phases of business 
cycles succeed one another is not invariable. A revival of business activity 
does not always develop into prosperity—sometimes it relapses into de¬ 
pression.” (Business Cycles, p. 449.) 

Yet in spite of his caution Mitchell proceeds to outline the inner workings 
of business cycles in the following language: "Low prices and the wearing 
out of semi-durable goods bring eventually an increase in the physical 
volume of purchases, stimulating production and business optimism, increas¬ 
ing employment and thereby the general purchasing capacity, and starting 
a rise in prices beginning with raw materials, wholesale prices, and pro¬ 
ducers’ goods. Overhead and labor costs lag behind and hence the great 
increase in profits which tempts a marked expansion of investments. This 
prosperity accumulates stresses which eventually lead to disaster. Overhead 
costs increase with expansion and the expiration of old contracts; the ef¬ 
ficiency of labor declines through excessive over-time and the employment 
of 'undesirables.’ Expansion of credit increases the tension of the invest¬ 
ment and the money markets due to heavy investments. The extraordinary 
demand for new equipment cannot be maintained indefinitely. The rise of 
prices threatens reduction of profits to an important minority and their 
difficulties precipitate a tightening and liquidation of loans which spreads 
throughout the money market. Sudden contraction due to the need of meet¬ 
ing liabilities results in overwhelming liabilities often involving a panic. 
The wholesale discharge of workers reduces consumers’ demand sharply, 
while the demand for new equipment is, in the absence of investment, prac¬ 
tically nil. Prices and costs fall, but after a period, as we have already 
seen, demand increases, and the cycle recommences. 

"Such is, however, only a generalized sketch. Some few industries, public 
utilities with fixed demand and prices and highly variable costs, or cheap 
commodities which will be substituted in enforced economy, prosper in a 
general depression. Between different industries, or even between different 
establishments in the same industry, the timing and intensity of the cycles 
vary so greatly that some will reach the peak of their prosperity after others 
have touched the bottom of their decline.” (Summarized in Blum’s Labor 
Economics, p. 233.) 

Those crises which have appeared between 1893 and 1929 all seem to 
have conformed to the mechanics of Mitchell’s analysis. It is doubtful, how¬ 
ever, that his description will fit all crises. It seems, therefore, that if we 
are to approach the problem of "business cycles” inductively it becomes 


BUSINESS CRISES 


181 


necessary to study each one separately. That means, also, that the study can 
be made only after the crisis has passed. An attack of that kind precludes 
any explanation of crises which can be made the basis of offering a solution 
to the problem. 

Cassel, however, approached the proposition with greater assurance. As 
a result he presents one of the most searching analyses of the problem that 
appear in economic literature. 

Cassel* s Thesis —Stated in a summary way, Cassel’s theory of business 
crises is that they occur because of the fact that capital investments respond 
disproportionately to deviations from proportional rises and falls in consumer 
demand. He bewails the lack of data to show accurately the fact that in¬ 
vestments tend to respond inordinately to small changes in demand for 
products. He does show, however, that ship-building in England suddenly 
picks up when the freightage curve shoots upward. In common parlance, 
those engaged in shipping begin to visualize handsome returns whenever the 
shipping begins to increase in volume. The increased investment in ship¬ 
building naturally stimulates employment. Increased earnings stimulate buy¬ 
ing and business as a whole tends to improve. A similar study is made by 
re-working data supplied by Sauerbeck’s index figures. In this he shows the 
variations in the prices of minerals and other commodities. "A glance at 
the diagram shows how much more sharply the conjuncture-movements are 
reflected in the prices of minerals than in those of other things. The rise in 
the prices of minerals during high conjunctures is usually very acute, and 
it is followed after the crisis by just as pronounced a reaction. There is 
the same effect, though in an essentially less degree, for other commodities.” 
{Social Economy, p. 575.) 

Cassel, therefore, assumes that "a depression is a period in which the de¬ 
mand for permanent material means of production is smaller than in the 
antecedent high conjuncture. 'Over-production’ is not essential to a de¬ 
pression. It is enough that the actual production is less than is possible with 
existing means of production. The idle part of the productive capacity is 
usually, as may be seen in the diagram, only a small percentage. But for the 
owners this idleness means a loss, and it is increased by the fact that competi¬ 
tion for the available employment forces down prices. The workers also are 
to a certain extent bound up permanently with production. For them also 
the depression means a comparative idleness, or unemployment and pressure 
on wages. Hence the slight fall of the curve of the iron output is enough, 
as this output represents the total production of fixed capital, to cause severe 
disturbances of the whole social economy.” {Ibid., p. 568.) 

It may appear on the surface that Dr. Cassel is stating in another way 
the over-capitalization theory. The fact is, however, that his theory is 


182 


THE EXPANSION OF ECONOMIC CONCEPTS 


exactly the opposite of the over-capitalization thesis. That is shown by the 
following language: "It seems, then, that no link is missing in the chain 
that normally connects the producers with the consumers. How is it, in that 
case, that the chain breaks? The answer is: The typical modern high con¬ 
juncture does not mean over-production or an overestimate of the demands 
of consumers or the needs of the community for services of fixed capital, 
but an overestimate of the supply of capital, or of the amounts of savings 
available for taking over the real capital produced. What is overestimated is 
the capacity of the capitalists to provide savings in sufficient quantity. We 
must bear in mind that this capacity has to be estimated several years in 
advance, since, on the average, there are several years between the time when 
the work is planned and the time when it maks its full demand upon the 
community’s savings. The individual employer has no other means of judging 
the condition of the capital-market except the rate of interest. During the 
depression and the first part of each high conjuncture, however, the rate is 
low, or at least moderate. The demands for capital-disposal which results 
from the increased activity of employers in the sphere of the production of 
fixed capital do not yet make themselves fully felt. It is, therefore, quite 
possible that enterprises, such as the construction of houses, railways, etc., 
will be planned and even begun, in such quantities that, when their need 
of capital afterwards makes itself felt, it cannot be satisfied. 

"The high conjuncture must thus be pressed onward, but at last there 
will come a time when it is clear that the market cannot find savings for 
the purchase of the real capital produced in sufficient amounts. There must 
then be a sudden fall in the value of real capital, and employers must find 
it extraordinarily difficult to get the capital they need, either by loan or 
selling. On this they have not calculated in incurring the current liabilities 
they did in the course of their productive undertakings. When it becomes 
clear that they have gone astray on this point, the consequence is bound 
to be a general incapacity to meet liabilities incurred. This spreads wider 
and wider, as the whole business world depends to a great extent on the 
punctual discharge of obligations that fall due. There is bound to be an 
economic crisis.” {Ibid., p. 626 .) 

In a word, therefore, Cassel’s theory of economic crises is that they 
occur because of the fact that savings fail to keep pace with investment. This 
gives rise to a sort of vacuum in the social economy that produces the 
ground-swell and finally the break. In line with other students of the problem 
who have a clearly defined theory of crises, Cassel presents a remedy based 
on the assumed accuracy of his diagnosis. The remedy is suggested as 
follows: 

"This wrong estimate of the future condition of the capital market would 
not lead to such a catastrophe if the individual employer secured in advance 


BUSINESS CRISES 


183 


the whole of the capital he needs to carry out his plans. Under present con¬ 
ditions this can rarely be done. Share-capital, which is subscribed for the 
purpose of realizing a large undertaking, represents, as a rule, only a part; 
sometimes only a very small part, of the whole of the capital needed. 
People generally persuade themselves that in the future it will be possible to 
get the requisite capital by the issue of debentures, by bank-credits, and so on. 
Moreover, share-capital is, as a rule, not paid up at once. The payments are 
often deferred for fairly long periods. Here again, therefore, calculations 
are based on the capital market of the future. In addition, the share sub¬ 
scribers usually go beyond their own means and require capital that they 
must get by loans often only for a short period. It is clear that subscriptions 
of this sort do not, from the economic point of view, represent a real actual 
command of capital on the part of employers. But even in the case where 
the individual enterprise has secured capital in advance, this capital will be 
temporarily put out at interest before it is used in the enterprise and will 
be placed at the disposal of the community through the banks or in some 
other way. It will be used in other enterprises, and will from the economic 
point of view, be no longer available. In these complicated circumstances 
we can easily understand how the demands which actual enterprise makes 
upon the capital market of the future are not in their totality clearly realized, 
and how the capacities of this future market, to meet the demands, are over¬ 
estimated. The individual who would put his business on solid foundations 
has always the alternative of securing the whole of his capital from the start. 
If the deepest cause of the crisis is a wrong estimate of the possibilities of 
obtaining on the future market the capital that is required for carrying out 
an enterprise that has been begun, the best means of meeting the danger 
of a crisis is in this policy. Obviously, however, it can only be done in 
practice to a limited extent.” (Ibid., pp. 626-7.) 

The Cassel thesis is suggestive of two other descriptions of economic 
crises, viz., the one advanced by Foster and Catchings, and that of Mitchell. 
If the Foster and Catchings thesis be so corrected as not to contain the 
failure to recognize the distinction between capital and money the similarity 
becomes evident. Not being fully aware of the necessity to save so that the 
supply of capital can be amplified Foster and Catchings seem to hold that 
the government can bridge the gap by injecting more purchasing power 
into the channels of trade. Cassel realized that capital cannot be created by 
any legerdemain. Hence he concludes that the remedy can in practice be 
supplied only to a limited extent. 

On the other hand, the resemblance to the Mitchell thesis appears in 
Mitchell’s allusion to the stresses that develop during the period of rising 
prices. It might be argued that these stresses would not appear if the supply 


184 


THE EXPANSION OF ECONOMIC CONCEPTS 


of capital would keep pace with the expansion of business. It is interesting 
to note, therefore, that the two authorities who approach the problem in¬ 
ductively observe similar phenomena. 

Conclusion. —The point of view of the author is the treatment of 
business crises has been that of avoiding the temptation to speak dogmatically 
on a subject about which there is such a wide variety of opinions. The one 
thing most striking about all of the theories of crises is the assurance which 
each authority has of the accuracy of his own interpretation. Certainly they 
can not all be right. It may be possible, however, that there is a certain 
element of truth in each thesis. 

The author has no intention of offering an explanation of or a solution 
of business crises with any thought that can much improve on the work 
already done. Yet he makes bold, by way of conclusion, to focus attention 
on several points that have become evident from the analyses given. They 
are: (1) crises seem to be a concomitant of the automatic order; (2) as 
a natural consequence of economic freedom and the profit motive business 
men may be expected to run too rapidly at times into alluring business 
ventures; (3) the imitative instinct may be expected to impel men who lack 
the power of divining new sources of gains into ways already charted; (4) 
a program of price control through the manipulation of credits, though help¬ 
ful in many ways, can hardly be looked upon as a solution of the problem of 
business crises; (5) if the government exerts itself judiciously in the direction 
of facilitating a ready adjustment of supply and demand schedules for com¬ 
modities which do not readily find a market without that assistance, that is 
about all that can be expected from the government in a positive way of 
constructive action in preventing the recurrence of the dreaded economic 
disruptions; (6) the business man’s fate must remain in his own hands. 

It requires little proof to show that business crises are a concomitant 
of the automatic order. Under any system of conscious and positive adjust¬ 
ment of production to consumption crises are unthinkable. In previous orders 
the nearest approach to them were the well-known famines. These came 
as the result of crop failures. They contained none of the ear-marks of the 
modern business crises. The latter come in spite of rather than because of 
the shortage of sufficient consumable commodities. With the exception of 
famines the civilized world seems not to have experienced anything in the 
nature of business crises. In ancient Rome, when society began to assume 
characteristics somewhat similar to those of modern times, there were oc¬ 
currences not very different from the crises of today. This goes to show that 
they are the concomitants of capitalism. 

When men were left to find their own way in the business world un¬ 
molested, too many of them showed little if any originality. They tended 


BUSINESS CRISES 


185 


rather to imitate their fellows than to look for something different to do. 
There are certain aspects of this procedure that are beneficial—certainly to 
society as a whole. This is true because the new venture in the production 
of a commodity already on the market to succeed must either supply a com¬ 
modity of equal utility at a cheaper price or a better commodity at the same 
price. Because of the social gains from competition thus brought about, the 
law protects the new venture so long as it does not take an undue advantage 
of the ones already in the field. But the fact remains that the process can 
be carried too far. If business men should, as a rule, look for some unex¬ 
plored source of profits and bend their efforts in the direction of producing 
something of value the supply of which is clearly deficient, pressure would 
be relieved at the point most effective in hindering business crises. 

Theoretically if the price curve could be straightened out so that we 
should no longer pass through periods of rising and falling prices, each 
productive agency might be expected to adapt itself to that task for which 
it is best fitted. It must be remembered, however, that a stabilized price 
level is constructed on an assumed spontaneous relationship among producers 
of economic goods. No thought is entertained of attempting to stabilize 
the price of any particular commodity. A stabilized price level simply means 
that steps are taken to make credit easier when prices begin to fall, so that 
the greater availability of funds will offset a fall. Similarly, when the index 
numbers show a tendency for prices to rise, credit will be restricted for the 
purpose of offsetting that rise. Yet anything may happen within the field of 
individual commodities, as long as individual price falls are offset by similar 
rises in the tables from which index numbers are constructed. Then too, 
business may be "dull,” that is, few goods may be changing hands even 
though the prices may be unaltered. 

Yet if we can be relieved of the inordinate stimulation to production due 
to inflation of prices, one of the most vicious influences in connection with 
business crises will be eliminated. 

We have already explained, in a previous chapter, a desirable relationship 
between the government and merchandising. Thus far in human experience 
the government has tended to apply pressure at the wrong place. It attempts 
to doctor the marketing processes of goods which already find an easy 
market. If the government would give assistance in bringing about a ready 
adjustment of supply to demand, of valuable goods and services which do not 
tend to find a market otherwise, sweeping results might be seen in that new 
buyers would be injected into the markets to help to take up the slack of 
goods that have a lagging demand. In addition, new and different com¬ 
modities and services would be offered. The consequence would be a richer 
and more abundant social life—a less unbalanced production and con¬ 
sumption. 


186 


THE EXPANSION OF ECONOMIC CONCEPTS 


Beyond this the business men will have to be left to their own fate. 
If they cannot learn to direct their activities away from the over-manned 
industries and into un-charted fields of industry they will be forced to bear 
the consequences, and business crises may be expected to reappear at more 
or less regular intervals. 



(Irving Fisher ( 1867 - ) 


In the person of Dr. Irving Fisher we have one who, if he had lived in a more responsive 
age, might have sponsored a movement for the reorganization of society. Living as he does* 
however, in a period of great specialization and minute technical training, his enthusiasm for 
reform has been more or less restrained. His spirit is certainly akin to that of Proudhon. 
Proudhon was attempting to turn a trick which would prevent anyone from becoming finan¬ 
cially embarrassed. Much less visionary, and very much more reserved in his claims for his 
plan of reform, Fisher has none the less stood sponsor for an effort to give the world a better 
monetary system. Some day mankind may succeed in discovering a satisfactory measure of 
value that may be far different from that so long agitated for by Dr. Fisher; yet he will ever 


187 





































188 


THE EXPANSION OF ECONOMIC CONCEPTS 


have the honor of having labored vigorously for a better measure of value, and of having 
fired the human imagination with the positive vision of its accomplishment. 

It is in connection with his 'Purchasing Power of Money that we consider that Fisher, 
more than any other authority, has opened up the subject of the economic function of money 
in such a way as to challenge the attention of thinking men. Other treatises on money with 
which we are familiar are analytical and descriptive. Fisher’s treatment of the subject is 
dynamic. 

Irving Fisher was born at Sauergerties, New York, February 27, 1867. His father was 
the Reverend G. W. Fisher. He received both his A.B. and Ph.D. degrees from Yale. After 
taking his doctorate, however, he spent some time (1893-4) in Berlin and Paris. His profes¬ 
sional career has also been exclusively coupled with Yale University. From 1890 to 1893, he 
was tutor in mathematics; from 1893 to 189 3 he was assistant professor of mathematics. In 
the year 189 5 he switched over to political economy and served as assistant professor of that 
subject till 1898, at which time he was promoted to a full professorship. This position he has 
held ever since. 

Outside of his professional duties Professor Fisher has been active in a number of ways in 
the affairs of importance in the life of the Nation. For a time he was editor of the Yale 
Review, he has been a member of a number of governmental commissions, and has taken part 
in several organized efforts toward political and social uplift. Not the least of these has been 
his work in connection with Prohibition. 

His many publications in economics treat the subject mathematically. He is an outstand¬ 
ing representative of the effort to reduce economics to mathematical expressions. 


CHAPTER X. 


MONEY 

Growing out of the concept of value naturally is the concept of money. 
Possibly owing to the fact that every one is more or less familiar with money, 
a surprisingly few authorities have taken the trouble to define it. The result 
is that students are frequently left without a clear conception of the exact 
thing about which the discussion has centered. Frequently when a definition 
is given it is inaccurate. The fact is that so many means of payment have 
come to perform the principal function of money—that of a medium of 
exchange—that unless trouble is taken to fix the mind of the student on 
exactly what money is he may make the mistake of thinking some things to 
be money which cannot logically be so considered. 

A definition of money must at least make it possible for the student to 
identify money when he sees it. It should also make it possible for one 
to identify money even if one had never seen it. In fact it should even 
make it possible for one to describe money to some one who may never 
have lived in a society which employed money. 

The writer wishes to present the following as a working definition of 
money: Any means of payment that passes without question in exchange 
transactions within the limits of a given sovereignty. It is easily seen that 
there are means of payment that pass readily without being money. That is 
the case with checks, particularly cashiers’ checks; yet they are not money, 
for they expect to be cashed. Any means of payment that ultimately expects 
to be cashed is certainly not money. Any means of payment that does not 
have ultimately to be cashed to be good in exchange transactions is money. 

Not all money, however, is standard money. Money, therefore, has to be 
subdivided into standard money and fiduciary money. 

Standard money relates to a certain definite commodity in terms of the 
value of which all other values are quoted. The commodity might conceiv¬ 
ably be any one of many economic goods. The fact is, nevertheless, that very 
few economic goods are well adapted to be employed as standard money. 

There are at least seven qualities essential to an entirely satisfactory stand¬ 
ard money. They are (1) value, (2) cognizability, (3) homogeneity, (4) 
divisibility, (5) portability, (6) durability, and (7) stability of value. It 


189 



190 


THE EXPANSION OF ECONOMIC CONCEPTS 


requires very little thought to see why these qualities are essential to a perfect 
money. It likewise requires little thought to understand that not a single 
commodity possesses to a high degree all of the attributes enumerated. It is 
because of that fact that it has always been necessary for the real work of 
money to be done by some other commodity than that in terms of which 
all other values are quoted. This fact has given rise to fiduciary money as 
distinguished from standard money. 

The independent utility of the commodity chosen as standard money 
must be distinguished from its money utility. If this were not true fiduciary 
money would have to be cashed much as is now the case with checks and 
other means of payment than money. We are told that in certain stages of 
civilization pelts of animals have served as standard money. To avoid the in¬ 
convenience of handling the pelts themselves, small segments were clipped 
from them. These segments would represent the pelts and would pass from 
hand to hand, completing exchanges much as the pelt itself would have 
done had it been employed both as a standard of value and as a medium 
of exchange. It is readily seen, however, that when the final claimant ap¬ 
peared with the segment to claim the pelt, the claimant desired the pelt, 
most likely, not for its money utility but for its independent utility—possibly 
to make a garment. The value of standard money may be dependent on the 
independent utility, yet the money utility must always be distinguished from 
its independent utility. A similar thing can be said about the paper money 
today. It functions as money much as did the segment of the pelt. Likewise 
when presented for gold, that is done most likely to get gold not for its 
money utility but for its bullion utility—possibly to make an ornament. It 
is just here that we discover the difference between cashing a check and 
claiming gold with fiduciary money. The one is looking for a better means 
of payment—money utility—whereas the other is looking for a definite 
utility apart from that of purchase and sale. 

Examples of fiduciary money in our currency are: the various forms of 
paper money such as the national bank notes, federal reserve notes, federal 
reserve bank notes, gold and silver certificates, greenbacks, treasury notes of 
1890—all the paper currency. In fact all the money except gold coins are 
fiduciary money. The independent value of the metals other than gold 
bears a higher ratio to the money value than does that of paper money. Yet 
the fact that the money value is greater than the independent value of the 
baser coins must be taken as evidence of the fact that these are also to that 
extent fiduciary money. 

The distinction between fiduciary money ana standard money enables 
us to avoid the error sometimes made by writers in attempting to distinguish 
between money and currency. Currency is money even though it may not 
be standard money. Standard money is in fact seldom employed as currency. 


MONEY 


191 


There are, however, many instruments of credit that function in exchanges 
quite as well as money—sometimes better. Yet they are not money, else 
there would not be certain formalities for their acceptance. 

Brief History of Money. —The story of the origin of the use of money 
is lost in the past. This statement, however, is not true of the origin of 
coinage. As soon as the primitive man began to quote the values of other 
commodities in terms of any one particular commodity money had made its 
appearance. The practice of resorting to money in balancing values originated 
long before anything like a uniform monetary system appeared. The evi¬ 
dence of this fact is beyond refutation. As many different sorts of standard 
money have been employed as there have been races of men. Just why any 
particular tribe employed a certain thing as a standard of value can never 
be positively known. It can, nevertheless, be positively known that particular 
tribes did employ certain things as standard money. For instanace, we know 
that Ancient Greece and Rome measured values in terms of cattle. We even 
have survivals of that fact in our own vocabulary, for instance pecuniary. 

The Breakdown of Barter. —Trading, itself, seems not to have been in¬ 
stinctive. The fact is that no animal except man has ever resorted to that 
practice. The first form of trading therefore was of necessity very crude. It 
could not have been other than that of "swapping” goods for goods—barter. 

Some tribes developed a fairly advanced form of civilization without 
learning to resort to money. This is notably true of the Incas in South 
America. There are other tribes that discovered the convenience of money 
long before they attained any great degree of civilization. In spite of that 
fact barter is at best a highly unsatisfactory method of exchange. The main 
difficulties of barter are not far to seek: 

(1) The first is that of equalizing values. One savage might value his 
canoe more highly than another did his pony. This difficulty could be over¬ 
come, however, by throwing in so much "to boot.” It is very likely that 
in the practice of "throwing in so much to boot” the first money originated. 
Naturally the thing which would be thrown in would be something which 
most other members of the trible desired. Among the Indian tribes in 
America it might have been arrow heads, or beads. This fact would seem to 
explain why different tribes utilized different commodities for money. But 
it does not explain the fact that cattle became standard money in early 
Greese and Rome. All that we can say about that is that they must have 
traded in terms of rather large units of value, and that they were a pastoral 
people. 

(2) The second difficulty is that of finding the parties willing to trade. 
Under a system of barter there could be no well developed market centers. As 
illustrative of this point Prof. Gide relates the following: 


192 


THE EXPANSION OF ECONOMIC CONCEPTS 


"Lieut. Cameron, who travelled in Africa in 1884, tells us how he had 
to go to work to obtain a boat: 'Syde’s agent wished to be paid in ivory, 
of which I had none ... So I gave Mohammed ibn Gharib the requisite 
amount of wine, upon which he handed over cloth to Mohammed ibn Salib, 
who, in turn, gave Syde ibn Habib’s agent the wished for ivory. Then he 
allowed me to have the boat.” (Gide’s Principles of Political Economy , 
p. 187n.) 

There may be other objections to barter but the ones mentioned are 
enough to show the great convenience of money. 

Coinage. —The precious metals served as money long before they were 
coined. Likewise coinage itself was resorted to long before man learned to 
make a satisfactory coin. 

"It is one thing to use the precious metals as an instrument of exchange, 
and another thing to use them as money, in the strict sense of the term. 
Progress from the one to the other is marked by three distinct stages. 

" (1) The precious metals were first used in the form of crude ingots. In 
every exchange transaction, therefore, these ingots had to be first weighed 
and then assayed. The legal form of ancient Roman law, such as mancipatio 
and its accompanying lihripens, retained the symbolism of the time when the 
instrument of exchange—silver or bronze—was weighed. And in China, 
where coined money was not employed, the merchants could have been seen, 
until recently, carrying their scales and touchstone at their girdle. 

"(2) When men grew tired of having to carry out this double process 
every time they made an exchange, it occurred to them to use shaped ingots, 
whose weight and fineness were determined beforehand and certified, if neces¬ 
sary, by some official seal or stamp. The lawgiver who first conceived this 
ingenious plan may claim the glory of having really invented money. For 
thereafter the ingots were no longer weighed but counted , and that is the 
characteristic of money. It seems likely that it was a king of Lydia, a suc¬ 
cessor of Gyges, who coined the first money, about 700 to 650 B. C. Speci¬ 
mens of his coins may still be seen in the British Museum. They are made 
neither of gold nor of silver, but of an alloy of these two metals which the 
Greeks called 'electron,’ and instead of being round they are egg-shaped or 
bean-shaped, and bear no mark except a few strokes and three indentations. 
In China also, until quite recently, the ingots often bore the marks of 
certain business houses, intended to certify their weight and fineness. 

"(3) One step yet remained to be taken. Not only was the shape of the 
cubical or irregular ingot somewhat inconvenient, but also, in spite of the 
stamp, nothing was easier than to 'clip’ it without detection. It was still 
necessary to weigh it, therefore, to make sure that it was intact. To remedy 
these practical drawbacks men were led to adopt the form of coined money 


MONEY 


193 


that is familiar now to all civilized peoples—little discs covered on both sides 
and on the edge with raised impressions, so that no one can file them or 
tamper with them without leaving visible traces on the design. 

"Thus was reached the typical coin or piece of money in the proper 
sense of the word, and for hundreds of years it has not been appreciably 
modified. We can adopt for it the definition given by Jevons: 'Coins are 
ingots of u/hich the weight and fineness are guaranteed by the government , 
and certified by the integrity of designs impressed on the surfaces of the 
metal.’” (Gide: Principles of Political Economy, p. 210.) 

Represenative Money .—Just as the knowledge of the origin of money is 
lost in the past so is that of the origin of representative money. The prac¬ 
tice of employing some kind of representative money seems to be almost as 
old as the practice of employing money itself. 

Distinction, however, has to be made between representative money which 
merely serves for convenience to save the trouble of handling the commodity 
itself (such as the segment of a pelt) and representative money which 
substitutes for money. 

"It was known in China from time immemorial, and Marco Polo, the 
fourteenth century traveler, brought back an account of it. And among the 
many kinds of money used in ancient times, if we find no record of paper 
money we at least hear of leather money of purely conventional value. That 
was called obsidional money, or siege money, because it was generally issued 
in besieged towns as a substitute for metallic money that was wanting.” 
{Ibid. p. 23 8.) 

In this connection we can hardly find a more applicable statement than 
that made by J. S. Mill at the very beginning of his Principles of Political 
Economy: "In every department of human affairs, practice long precedes 
science: systematic inquiry into the modes of action of the powers of nature 
is the tardy product of a long course of efforts to use these powers to prac¬ 
tical ends. The conception, accordingly, of Political Economy as a branch of 
science, is extremely modern; but the subject with which its enquiries are 
conversant has in all ages necessarily constituted one of the chief practical 
interests of mankind, and, in some, a most unduly engrossing one.” 

Although, therefore, we may experience difficulty in finding the origin 
of certain practices regarding money, the same difficulty hardly exists 
with regard to the history of scientific treatment of the subject. This begins 
and grows with the science of economics. 

Money functions in two ways, namely, individually and socially. The 
individual and social functions of money are of necessity closely related. Yet 
money may be entirely acceptable in its individual or private functions and 
yet be far from satisfactory in its social chracteristics. It is highly desirable, 


194 


THE EXPANSION OF ECONOMIC CONCEPTS 


therefore, that we distinguish clearly between the individual and the social 
functions of money. 

The Private Function of Money .—In private relations money has three 
main functions. They are: (1) store of value; (2) medium of exchange, and 
(3) standard of value. Each of these requires some explanation. 

The store of value function may in some instances better be performed 
by some other commodity than money. We are told that immigrant families 
often, before leaving the other side, will sell all of their possessions and with 
the money thus realized purchase diamonds. Upon arrival they will sell the 
diamonds and with the money thus realized purchase other "possessions” 
which serve the purposes formerly performed by those disposed of in the first 
instance. The diamonds clearly were not desired for any other purpose than 
that of storing the value during the trip. Naturally gold could have served 
almost as well. The function of store of value is probably not as important 
as it once was. But even yet the function is performed to no small extent by 
money. The most frequent instance is that performed by "pocket change” 
of the individual and "till” money in banks. 

The medium of exchange function has already been mentioned in our 
allusion to barter. Instead of waiting to find the person who possesses the 
object of one’s desire and at the same time desires that which one has to trade, 
one can with the use of money "sell” what he has and buy what he wants. 
Many complications may appear before the exchanges will balance perfectly 
so that those goods which are offered on the market will pass in exchange for 
other goods offered. But the fact remains that the exchange of goods for 
money and, in turn, of money for goods is the most important step in secur¬ 
ing the advantages of division of labor. 

Money as a standard of value, considered from the standpoint of the 
individual, amounts only to a simplification of ratios. Instead of counting 
the value of each commodity in terms of the values of all other respective 
ones in a series, with the use of money the values of each other one in the 
series is quoted in terms of only one. "Without such a standard the value 
ratio between each commodity and every other dealt in must be remembered 
by the trader. For example, if he deals in ten commodities there will be forty- 
five ratios of exchange to be remembered. The use of a standard of value 
enables him to substitute for these forty-five possible exchange ratios the 
nine ratios between the selected commodity and the others. The smaller 
number of ratios under the new system tell exactly the same story as the 
larger number did before. Thus, instead of remembering that a string of 
beads is worth four deer, that two deer are worth an arrow-head, and that 
two arrow-heads are worth a string of beads, it suffices for the trader to 


MONEY 


195 


remember that a deer is worth one-quarter, and an arrow-head one-half of a 
string of beads.” (Seager’s Principles of Economics, p. 323 .) 

The standard of value function brings us now to the social as distin¬ 
guished from the private functions of money. 

The Social Functions of Money. —Money v. Wealth. To set the 
distinction between money and wealth in its clear perspective it will be 
well to begin a little further back than we have done for most other economic 
concepts. It is probably in connection with this one point more than any 
other that the science of economics had its inception. Certainly Adam Smith’s 
main objective was to overthrow the Mercantilist concept of wealth. This 
concept was so closely associated with that of money and Adam Smith’s 
objective in this regard was so conclusively to show that their thesis was 
untenable that these two points of view deserve careful attention. 

The prime fallacy of Mercantilism grew out of the fact that the Mer¬ 
cantilists carried the individual concept of wealth over into the social con¬ 
cept. They saw that if an individual increased his money supply he increased 
his wealth. Without seeing the demarcation between the individual and the 
social functions of money they concluded that whatever was a source of 
private wealth was likewise a source of public wealth. 

It takes critical analysis to see how it is that a private individual may 
increase his wealth by a method which is not, by the same line of reason¬ 
ing, the source of public wealth. Certainly national or public wealth is the 
total of the wealth of the citizens. Why then is it true that a private individ¬ 
ual increases his wealth by increasing his command over money whereas 
national wealth is not so increased? 

We need to call to mind the fact that wealth is composed of all want- 
satisfying goods. These goods are not equally valuable for the very simple 
reason that they are not equally abundant—or better—not equally abundant 
relatively to the desires for them. The fact of scarcity (scarce utility) gives 
rise to value. Money comes in to measure the relative value of goods. The 
main social function of money, therefore, is that of measuring values. The 
whole supply of money comes to have a ratio to all goods. Just how much 
money is needed may be a cause of some controversy. Whether the amount is 
small or not, each subdivision of that amount has a greater purchasing power 
than would be true if the amount were large. In its simplest aspect socially 
the money-to-goods relationship is merely a ratio. A mere increase in amount 
of money, therefore, has no effect on wealth. It merely means that each frac¬ 
tion of the whole has less purchasing power. The only way known to man to 
increase wealth of the world is to increase the total amount of want-satisfy¬ 
ing goods. That cannot be done merely by increasing the amount of money, 
except to the very small extent of the actual increase in amount of gold that 


196 


THE EXPANSION OF ECONOMIC CONCEPTS 


may be made by the increase in the amount of money. Of course when the 
concept of wealth is cosmopolitan instead of national one nation may acquire 
a slight advantage over another under some circumstances because of its 
augmented supply of gold. That point will receive attention in connection 
with the theory of international trade. 

The very fact of an individual’s ability to increase his wealth by increas¬ 
ing his command over money is dependent on an assumption of a more or 
less constancy in the total supply of money. If money itself cheapens suffi¬ 
ciently to offset any increase in amount which the private party may secure 
the latter does not increase his wealth by increasing his supply of money. 
The reason the individual increases his wealth by increasing his command over 
a certain amount of money is explained, therefore, by the fact that his 
additional supply of money gives him a relatively larger command over the 
limited supply of valuable goods. 

The above fact, however, has an important social consequence. Each 
private individual, in his eagerness to increase his command over the limited 
supply of want-satisfying goods, by increasing his money supply, tends to 
direct his productive effort in the direction of securing those goods which 
command a high price. Goods which command the high prices are the ones 
which are most scarce relatively to human desires. Hence individuals in 
seeking to put on the market goods which sell well by the very process of 
attempting to increase their wealth by increasing their command of money 
supply in fact increase the social wealth also. 

Unfortunately the Mercantilists, in assuming that nations could increase 
their wealth by increasing the money supply, failed to see that such an 
increase in money supply of the nation did not come as a result of any 
addition that the nation might have made to its want-satisfying goods 
and services. It merely resulted in a disturbance of the ratio of money to 
goods already existing. As we have noted, there is an important relation 
between international exchange situations and the wealth of any particular 
nation somewhat analogous to that of the individual purchasing power and 
the wealth of the community as a whole. A comprehension of that fact, 
however, is based on a point of view diametrically opposed to Mercantilism— 
that of an unregulated international flow of gold. 

The Mercantilist Concept Overthrown .— (1) The Physiocratic thesis. 
The Physiocrats did very little with the subject of value and less with the 
subject of money. Yet one of the best replies to the general import of the 
mercantilist concept of money came from Mercier de la Riviere, when he 
said: ”1 will drown the clamour of all your blind and stupid policies. Suppose 
that I give you all the money which circulates among the nations with whom 
you trade. Imagine it all in your possession. What would you do with it? 
Upon final analysis do you find that you have gained anything by your policy 


MONEY 


197 


of always selling to foreigners without ever buying from them? Have you 
gained the money by the process? But you cannot retain it. It has passed 
through your hands without being of the least use. The more does its value 
diminish, while the value of other things increases proportionally.” (Quoted 
in Gide and Rist, p. 31.) 

(2) Adam Smith’s Challenge of Mercantilism. —In Adam Smith’s scorn 
for the Mercantilistic concept of money he went even too far in minimizing 
the importance of money. Money to Smith was nothing more than a "great 
wheel of circulation”. In evaluating a nation’s wealth money had to be left 
out, for it was not consumed. It only served as an instrument for the circu¬ 
lation of wealth and a very unsatisfactory measure of value. The following 
quotation is illustrative of Smith: 

"The real price of everything, what everything really costs to the man 
who wants to acquire it, is the toil and trouble of acquiring it. What every¬ 
thing is really worth to the man who has acquired, and who wants to dispose 
of it or exchange it for something else, is the toil and trouble which it can 
save to himself, and which it can impose upon other people. What is bought 
with money or with goods is purchased by labour, as much as what we 
acquire by the toil of our own body. That money or those goods indeed save 
us toil. They contain the value of an equal quantity. Labour was the first 
price, the original purchase money that was paid for all things. It was not by 
gold or by silver, but by labour, that all the wealth of the world was origi¬ 
nally purchased; and its value, to those who possess it, and who want to 
exchange it for some new productions, is precisely equal to the quantity of 
labour which it can enable them to purchase or command.” ( Wealth of 
Nations , Vol. I, Book I, Chap. V.) 

(3) Ricardo and the Social Functions of Money. —In Ricardo’s time the 
money problem had become a burning political question. In his discussion of 
money he settled once and for all some of the most disputed questions, and 
in others he quieted the debate for nearly a century. Yet in all respects he 
was unable to break away from the influence of his great teacher^-Adam 
Smith. That fact is evident in the following quotation: 

"Gold and silver, like other commodities, are valuable only in proportion 
to the quantity of labour necessary to produce them and bring them to 
market. Gold is about fifteen times dearer than silver, not because there is 
greater demand for it, nor because the supply of silver is fifteen times 
greater than that of gold, but solely because fifteen times the quantity of 
labour is necessary to procure a given quantity of it.” ( Principles , Chap. 27.) 

And he continues: "The quantity of money that can be employed in a 
country must depend on its value; if gold alone were employed for the cir¬ 
culation of commodities, a quantity would be required one-fifteenth only of 
what would be necessary if silver were made use of for the same purpose. 


198 THE EXPANSION OF ECONOMIC CONCEPTS 

/ 

"A circulation can never be so abundant as to overflow; for by diminish¬ 
ing its value in the same proportion you will increase its quantity, and by 
increasing its value, diminish its quantity.” 

It was in his essay on "The High Price of Bullion ,” that Ricardo made 
his main contribution to the theory of money. It was here that he gave 
attention to the controversy over the cause of the exportation of gold. It 
was here also that he explained the nature of international movement of 
gold in such a way as to allay forever the Mercantalist confusion of wealth 
and the precious metals. 

In his discussion of the relation of prices to gold Ricardo showed that 
the high price of bullion was not due to the exportation of gold but that 
the exportation of gold was due to the excessive issues of paper money. He 
did this so effectively that since his day no one has seriously questioned the 
proposition. With a sort of prophetic insight he remarked: "There is no 
point more important in issuing paper money than to be fully impressed 
with the effects which follow from the principle of limitation of quantity. 
It will scarcely be believed fifty years hence that bank directors and minis¬ 
ters gravely contended in our times, both in Parliament and before commit¬ 
tees of Parliament, that issues of notes by the Bank of England, unchecked 
by any power in the holders of such notes to demand in exchange either 
specie or bullion, had not, nor could have, any effect on the prices of com¬ 
modities, bullion, or foreign exchange.” ( Principles , Chap. 27.) 

With regard to the movement of gold in international trade Ricardo 
showed that gold tended to flow automatically to the nation where it was 
most needed. A clear exposition of this point must await our analysis of 
international trade. But briefly the proposition is that international trade 
balances give rise to demand for gold for the purpose of settling accounts. 
If the trade has been larger from one nation to another than from the other 
nation to the first, then the difference needs to be paid in gold. But, in 
obedience to the relation of the quantity of money and prices, whenever the 
gold left one nation and flowed into the bounds of another, the diminished 
supply of gold in the nation giving it up caused prices there to fall and the 
increased supply of gold in the bounds of the nation to which the gold flowed 
caused prices there to rise. These facts induce the trade balance to recover 
itself because of the fact that enough more purchases would be made in 
the nation whose prices had fallen for the slack to be taken up, etc. Thus 
gold needed to be entirely undisturbed so that its neutralizing influence on 
price movements from one toation to another might be more certainly 
effective. 

A doctrine of that kind is almost a by-word with us today. In Ricardo’s 
day is was almost heresy to advance it. Ricardo’s demonstrations were largely 
responsible for the changed attitude toward gold movement. 


MONEY 


199 


With regard to the gold movement in international trade, however, both 
Ricardo and Smith saw that the gold movements were but tardy methods of 
adjustment of international balances. They called attention, as well, to the 
fact that it was not necessary to wait, usually, for the movement of gold to 
make the adjustments. The rise and fall in exchange rates were in most 
instances enough to take up the slack. It seemed never to have occurred 
to them, however, to dig deeply into the problem of discovering the forces 
which control the movement of trade in the absence of the stabilizing influ¬ 
ence of gold. This problem has been attacked in our own day with the result 
that students are beginning to question the scientific accuracy of certain of 
Ricardo’s conclusions regarding the relation of gold to international values. 
These investigations, however, in no sense mean a return to a conscious policy 
of control of gold movement in any respect similar to that which Ricardo 
challenged. It simply raises the question as to whether or not the gold move¬ 
ment cannot more advantageously be done away with altogether. A fuller 
discussion of this point will be found in a later chapter. 

Money and Value.— The prime social function of money is that of 
measuring value. We have already made reference to this function in our 
treatment of value and price. At this point we shall consider, in a more 
detailed way, the relation between money and value. 

The chatoic condition of the theory of value during the period of the 
early classical economists made their treatment of the relation of money to 
value of only mediocre importance. That was seen in the quotations of a 
few pages back. The labor theory of value permeates their analyses of the 
theoretical functions of money. 

All through the early classical economics we find the quantity theory of 
money accepted categorically. 

But their treatment of that aspect of the subject of money is so much 
linked up with bank currency, the labor theory of value, and capital values, 
that little helpful information can be secured from it. The fact is that the 
whole of the nineteenth century is a period of chaos with regard to the 
theoretical relationship between money and value. Even yet there is no small 
amount of groping in the darkness among those who discuss theoretically 
the relation between money and value. There are, however, a few propositions 
which may be taken as universally accepted. Some of the more outstanding 
of these are now to be taken up. 

Prices and the Value of Money Vary Inversely .—We are probably safe in 
stating, without danger of serious question, that if prices rise the value of 
money goes down proportionally, and vice versa. If it takes more of a thing 


200 


THE EXPANSION OF ECONOMIC CONCEPTS 


to secure another than it did at any previous time then that thing is less 
valuable in terms of the other thing than it was at the previous time. If on 
the average it takes more money to produce the objects of our desire than 
it formerly did, the value of money has gone down, and vice versa. In other 
words when prices go up, the value of money goes down and when prices go 
down, the value of money goes up. The natural conclusion is, therefore, that 
if prices should remain stationary the value of money would be constant. 
Since prices do not remain stationary, the value of money is not constant. 
Since the value of money does not remain constant, thus far in the history 
of the world we have not found a perfect money. 

Changes in the Value of Money Have an Unfortunate Influence on 
Exchange Transactions. —It is sometimes stated that one of the functions of 
money is that of a standard of deferred payment. If this could logically be 
thought of as a distinct function of money, it would, of course, have to be 
classed as one of the social functions. If, however, money were a perfect 
measure of value, the measure would not change and a contract calling for 
the payment of a certain amount of money at some future time would 
mean the same purchasing power as that amount of money in the present. 
Of course the future values would have to be corrected to take care of inter¬ 
est credits. But that is another question. Interest could be more nearly accu¬ 
rately calculated if money had a constant purchasing power than it can be 
when society has to reckon with changes in purchasing power. The measure 
of value function relates, therefore, not only to present values but also to 
future values. The assumption of a standard of deferred payment function 
as distinct from the measure of value function seems to grow out of the 
fact that money does not have a constant purchasing power. To speak of a 
defect as a function seems to the author to be little less than ridiculous. 

The unfortunate consequences of the tendency of money to vary in 
value have been well stated by Professor Alfred Marshall as follows: "Let us 
suppose, for instance, that a man borrows £100 under contract to pay back 
£105 at the end of the year. If meanwhile the purchasing power of money 
has risen 10 per cent, (or which is the same thing, general prices have fallen 
in the ratio of 10 to 11), he cannot get the £105 which he has to pay back 
without selling one-tenth more commodities than would have been sufficient 
for the purpose at the beginning of the year. Assuming, that is, that the 
things which he handles have not changed in value relatively to things in 
general, he must sell at the end of the year commodities which would have 
cost him £115. 10s at the beginning, in order to pay back with interest his 
loan of £100; and therefore he has lost ground unless the commodities have 
increased under his hands l5/z%. While nominally paying 5% for the 
use of his money, he has really paid 15 *4%. 


MONEY 


201 


"On the other hand, if prices had risen so much that the purchasing 
power of money had fallen 10% during the year, and he could get £100 for 
things which cost him £90 at the beginning of the year; then instead of 
paying 5% for the loan, he would really be paid 5/z% for taking charge of 
the money.” (Marshall’s Principles of Economics , p. 594.) 

It is readily seen, therefore, that a rise in prices in decidedly to the ad¬ 
vantage of the debtor class, while a fall in prices is likewise an advantage to 
the creditor class. This fact itself has a powerful influence on the attitude 
frequently assumed by certain persons toward an inflationist, or for that 
matter, a deflationist policy on the part of the government. The debtor class 
naturally are eager for prices to rise, for if they do, it becomes increasingly 
less difficult to extinguish their obligations. The reverse attitude is taken 
by the creditor class, for the reason that the settlement of their contracts is 
always made by their receiving something more than the contract calls for. 

An economic consideration of no small consequence is the effect of a 
cheapening of money on those who live on an independent income. The fact 
is that their income always tends to purchase less and less during the period 
of rising prices. This makes it harder and harder for them to live on their 
independent incomes. This fact tends to force them out of their positions 
of security and idleness into the ranks of producers. A contemplation of this 
phenomenon leads some persons honestly to favor a continual rise in prices. 

Measuring Price Changes .—It has been well said that the fact that a 
measure is inaccurate is of small importance if one knows the extent of its 
variation from accuracy. The fact that most measures vary slightly from 
absolute accuracy makes it necessary for corrections to be made in practically 
all instances where absolute accuracy is sought. 

Unfortunately the inaccuracy of money as a measure of value carries a 
more disastrous consequence than is true of most other inaccuracies of meas¬ 
ures. If my watch is, say, ten minutes slow or fast, all that I need to do is to 
remember that fact and add or subtract ten minutes from the time which it 
indicates to discover the correct time. Even if it loses or gains a certain 
amount each day I can, by making the necessary correction, ascertain the 
exact time. 

Yet, if we could find a way to correct accurately the measure of value, 
the mere knowledge of the exact extent of error would not be sufficient to 
remove the consequences. If, for instance, I am aware that the purchasing 
power of money has declined ten per cent, during a certain period, the knowl¬ 
edge of that fact will be of small avail to me in securing my due. The con¬ 
tract probably calls for the payment of a certain amount of money. Unless 
an extra clause has been inserted the contract giving me the right to claim 


202 


THE EXPANSION OF ECONOMIC CONCEPTS 


also as much value as the money has lost in purchasing power during the 
interval, I am helpless. In fact the knowledge of the loss of value might 
be a source of discomfort to me. Yet the ability to correct the error in regard 
to money as a measure of value is of enough interest to have called out a 
number of technical treatments of the subject. The device employed is known 
as index numbers. 

A number of different systems of index numbers are employed for this 
purpose. All of them, however, are but different methods of attempting to 
discover the same tendency, namely, how much the purchasing power of 
money has varied from what it was at a definite time in the past. The time 
of reckoning is more or less arbitrarily selected, and is known as the base 
year. If prices are on the average at a certain point at or during the designated 
time, and if they have varied from that average, the purchasing power of 
money has changed by the amount of that variation. The differences with 
regard to methods of working index numbers relate to how best to (1) 
find the average during the base year and (2) how best to discover the 
variation from that average. 

With regard to the first of these a number of puzzling questions develop. 
What goods should be selected? How many different articles should be 
included in the list? Should retail or wholesale prices be the basis of the meas¬ 
ure? In what market should the data be secured? Answers to these questions 
would lead us into a treatise on index numbers. A relatively small comprehen¬ 
sion of economic theory will reveal many complex problems involved in 
satisfactory answers to them. 

Assuming, however, that we have arrived at a fairly satisfactory answer 
to any or all of these questions, the problem remains of how best to discover 
the extent of variation from one time to another. At least four distinct plans 
are resorted to. They are (1) the median—the price which hits at the middle 
point, that which has as many entries below it as above it; (2) the simple 
arithmetic mean—a comparison of the different arithmetic averages: (3) the 
weighted arithmethic mean—in which the clearly more important entries are 
given greater relative importance than the less widely consumed articles; 
and (4) the geometric mean. In this the nth root is extracted from the 
product of n commodities in each list. This method is somewhat preferred 
because it eliminates a significant defect of the arithmetic average, that of 
exaggerating the price rise. (A 50% rise checks against a 33 l/3% fall.) 
The use of the geometric mean, however, is possible only by resorting to 
logarithms. The difficulty of utilization, therefore, makes it an unpopular 
method. 

In conclusion, therefore, we must say that the perfect method of cor¬ 
recting for error the variation in money as a measure of value has not been 


MONEY 


203 


found. * Yet we know well enough that if a representative list of commodi¬ 
ties has on the average an index of 100 at any particular time, and that the 
price has gone up so that the average now stands at 150, the value of money 
has gone down one-third in so far as it relates to those particular commodi¬ 
ties. It takes $1.00 to buy what was bought for 66 2/3 cents. The ease of 
calculating the artithmetic average along with the fact that the other meth¬ 
ods do not give results very far different, has led to a wide acceptance of 
that method. 

Efforts are Being Made to Discover a More Perfect Measure of Value .— 
Up to this point in our discussion very little has been said about the com¬ 
modity in terms of which other values are quoted. If the value of money is 
synonymous with the value of the commodity employed as money, and if 
we could find something which did not change in value, then we should 
have a perfect money, i. e., if it at the same time possessed the other qualities 
essential to a good money. The fact that the value of gold is steadier than 
that of any other known commodity has resulted in the well-nigh universal 
adoption of the gold standard. Yet no small amount of attention has been 
given to the question as to whether or not a better standard might not be 
found. If through some unforeseen occurrence gold should become as cheap as 
dirt, then society would be forced to hunt another standard. 

(1) Bimetallism. Of the many suggestions that have come for a better 
standard only one has been actually tried. That one is bimetallism. 

The philosophy behind experiments in bimetallism is that of having the 
monetary unit, say the dollar, stand for either of two metals, gold or silver. 


*At the outset of our chapter on money we called attention to the fact that Professor 
Irving Fisher has done outstanding work in opening up the problem of money. In his more 
recent book on index numbers Dr. Fisher has made a critical analysis of all of the various 
methods of handling index numbers with the view of finding a measure of the change in the 
value of money which will give equal weights to changes both upward and downward. As a 
result of that study Dr. Fisher offers the following formula, which may well be considered as 
another contribution in the way of a mathematical formula to economic theory: 


V S P, (W B R Q' 

SRQo SPoQ. 

P = PRICES 
Q r QUANTITIES 
os BASE YEAR 
I s GIVEN YEAR 


(See Irving Fisher: The Making of Index Numbers, p. 360.) 






204 


THE EXPANSION OF ECONOMIC CONCEPTS 


When bimetallism is instituted care is exercised to have the coins struck off 
so that the amount of metal in each will represent the same value. That is 
done by having enough more of the cheaper metal in the coin to make it 
worth as much as that of the dearer metal. The necessary amounts are 
determined by what each is worth on the market. If gold is worth fifteen 
times as much as silver then the silver coin must have fifteen times as much 
in weight of silver as the gold coin has of gold. Bimetallism further assumes 
free and unlimited coinage of each metal. 

By this method it was thought that the compensatory action of the 
cheapening of one metal would be offset by the higher value of the other. 
Since there is not as much likelihood of two metals varying in value as one, 
the value of the monetary unit is more likely to remain constant if it repre¬ 
sents the value of either than would be true if it stood for the value of one 
alone. 

The practical adaptation of bimetallism for the purposes of a monetary 
standard has always resulted in the one or the other becoming the standard. 
Thus the benefits of bimetallism have in fact never been realized. The fact 
that one metal displaces the other is due to an economic law which was 
clearly stated many years before the development of the science of economics. 
This is the famous Gresham’s law. The fact is, nevertheless, that there never 
has been a genuinely scientific effort so to establish bimetallism as to nullify 
operation of Gresham’s law. 

Bimetallism as usually understood simply means that silver coins have 
exactly enough grains of silver in them to make their value equal to that of 
gold. If, for instance, 23.22 grains of pure gold are in the gold dollar and 
silver is worth on the market one-sixteenth as much as gold, then to make 
the silver dollar equal in value to the gold dollar it must have sixteen times 
as many grains of silver in it as the gold dollar has gold. In other words, the 
term dollar would mean either 23.22 grains of gold or 371.52 grains of silver 
at the mint. 

If the market ratio of the metals continued at sixteen to one, there would 
be no difficulty in maintaining a bimetallic standard. Yet, if that should 
happen, then the very purpose of the institution of bimetallism would be 
defeated. The ratios could remain constant only if the value of neither 
changed or if both changed together. If the value of neither changed, the 
very problem of variation in the value of money would cease to exist, and 
nothing further would need to be done. If they varied together, bimetallism 
would be in no respect superior to the gold or silver standard. 

It has always happened, however, that very soon after the establishment 
of the bimetallic standard in any country, either the one or the other has 
changed in value. It should be noted, however, that bimetallism does not 
fail because of the impossibility of keeping the ratio accurate in monetary 


MONEY 


205 


units. Bimetallism fails because of the impossibility of making the two metals 
circulate on equal bases after the ratio has changed. We have already noted 
that that comes as a result of Gresham’s law. Whenever two kinds of money 
are in circulation together the cheaper money will drive the dearer out of 
circulation. 

We may ask why that happens. There are several reasons. One is that 
of hoarding. If I have two dollars either one of which may be employed as 
money and one is worth $1.10 as bullion in terms of the other as money, 
naturally, I will employ the less valuable one with which to make payment. 
Other persons being impelled by the same impulse, very soon all of the 
dearer coins have ceased to circulate. As a result of this practice prices really 
go up enough to offset the decline in the value of money which actually cir¬ 
culates. This fact brings into play a force which tends to drive the dearer 
money out of the bimetallic country. This brings us to the second cause of 
the disappearance of the dearer metal. 

Silver dollars will buy gold dollars which in turn will buy more goods in 
a foreign country than at home. Hence persons possessing silver dollars will 
use them to buy gold dollars and take these gold dollars and buy goods 
abroad. Thus the cheapening of the one tends to drive the dearer out of 
the country. 

In the third place, whatever amount of the dearer metal that remains at 
home tends to be melted up and sold as bullion. If I can take silver dollars 
and buy gold dollars which in turn will net me ten per cent, profit if melted 
up and sold as bullion, naturally I will do that as long as there are any gold 
dollars that can be had for the silver dollars. 

Because of the above forces which invariably become operative whenever 
bimetallism is attempted, whichever metal cheapens really becomes the stand¬ 
ard. Thus far in the world’s history the bimetallic standard has never been 
successfully operated. 

It has been generally recognized, however, that there are at least two 
methods of procedure, either one of which might make bimetallism effective. 
They are (1) international bimetallism and (2) symmetallism. 

International Bimetallism. —It has been fairly well demonstrated that if 
all civilized nations should adopt bimetallism the operation of Gresham’s 
law would be stalemated. The value of gold and the value of silver are so 
nearly completely dependent on the demand for these metals for monetary 
purposes that if all nations agreed effectively to maintain an established 
ratio between gold and silver there is little doubt that the ratio could be 
maintained. At least we should no longer find the dearer metal exported. 
Any slight variation that might then occur in the value of one of the metals 
in terms of the other might logically tend toward the stabilization of the. 


206 


THE EXPANSION OF ECONOMIC CONCEPTS 


value of money. Since, however, in the present state of international affairs 
there is no likelihood of such an agreement, it is useless to consider it 
seriously. 

Symmetallism .—Professor Marshall has shown that it is entirely possible 
to secure the benefits of a dual standard. We give his own language: 

"Ricardo suggested that we should use paper currency resting on a basis, 
not of coin, but of stamped gold bars weighing 20 ounces each. If, he 
argued, the currency were in excess and showed signs of falling below its 
gold value, it would be taken to the mint and exchanged for gold bars for 
exportation; if it were deficient, gold bars would be brought to the Mint 
and currency demanded. Within the country the paper would be a perfect 
medium of exchange, while for payment of balances of foreign trade stamped 
gold bars are better suited than coins. 

"The currency scheme now submitted for consideration differs from his 
only by being bimetallic instead of monometallic. I propose that currency 
should be exchangeable at the Mint or Issue Department, not for gold, but 
for gold and silver, at the rate of not 1 for 113 grains of gold, but 1 for 
56 l /z grains of gold, together with, say, 20 times as many grains of silver. 
I would make up the gold and silver bars in gramme weights, so as to be 
useful for international trade. A gold bar of, say, 100 grammes, together 
with a silver bar, say, 20 times as heavy, would be exchangeable at the Issue 
Department for an amount of currency which would be calculated and 
fixed once and for all when the scheme was introduced. (This number, 20, or 
whatever it might be, would be fixed on arbitrarily once for all. If we wished 
the value of the currency to be regulated chiefly by gold we should have only 
a small bar of silver; if chiefly by silver we should have, perhaps, 50 or 100 
times as heavy a bar of silver as that of gold. But if we wished the two 
metals to have about equal influence we should, taking account of existing 
stocks of the two metals, probably choose our silver bar about 20 times as 
heavy as that of gold.) 

"Anyone who wanted to buy or sell gold or silver alone in exchange for 
currency could get what he wanted by exchanging gold for silver, or silver 
for gold, at the market rate. Government fixing its own rates from day to 
day, so as to keep its reserves of the two metals in about the right propor¬ 
tion, might safely undertake this exchange itself, and then anyone could 
buy or sell either gold or silver for currency in one operation. 

"To ensure convertibility the currency should not be allowed to exceed, 
say, twice the bullion reserve in the Issue Department, except in times of 
emergency, when the minimum rate of discount was, say, 10 per cent., and 
then the rule might be broken, either as now by authority of the govern¬ 
ment, or, which I think would be better, by a self-acting rule. The country 


MONEY 


207 


would save so much on the cost of its currency that it could well afford to 
keep, as a normal reserve, bullion worth, say, £20,000,000 in excess of this 
limit and thus prevent the sudden stringencies which we now suffer when¬ 
ever there is even a small foreign drain of bullion. There would be, as now, 
token coins of silver and bronze; but, since even a small percentage on the 
value of gold coin is sufficient to pay the illicit coiner, it is doubtful 
whether it would be worth while to have token coins of gold.” (Marshall’s 
Money, Credit and Commerce, p. 64.) 

The recent decline in the production of gold and accompanying fall in 
the price level may be the occasion for a revival of the suggestion advanced 
by Professor Marshall many years ago. It at least represents at the same time 
a feasible and scientific plan of operation of bimetallism so as to nullify the 
operation of Gresham’s law. 

Needless to say, however, if successfully instituted, it would not entirely 
do away with changes in the value of money. There are so many other influ¬ 
ences that enter into the price trends, that it is doubtful that any attack 
from the standpoint of the standard commodity can be completely success¬ 
ful in preventing the rise and fall in prices. A plan, such as that presented 
by Professor Marshall, however, would certainly relieve us of many harmful 
effects of the gold standard. To the extent that it did, the monetary system 
would be established on a higher plane. Closely linked with the proposition 
here developed is the quantity theory of money. 

(2) The Quantity Theory of Money .—There was no question in the 
mind of the early classical authorities that the value of money varies directly 
with that of the quantity of money. Among the later economists we dis¬ 
cover a small group of writers seriously questioning that theory. Although 
much of the difference of opinion grows out of failure to define terms, there 
is still enough genuine difference in their points of view to make it worth 
while to examine critically each side of the controversy. 

Although all of the early classical economists held to the quantity theory, 
it remained for J. S. Mill to state it in its exactitude. We submit that it was 
Mill’s concept here rather than that of Ricardo that has called out so much 
comment by the later authorities. 

"If we assume the quantity of goods on sale, and the number of times 
those goods are resold, to be fixed quantities, the value of money will de¬ 
pend upon its quantity, together with the average number of times that each 
piece changed hands in the process. The whole of the goods sold (counting 
each resale of the same goods as so much added to the goods) have been 
exchanged for the whole of the money, multiplied by the number of pur¬ 
chases made on the average by each piece. Consequently, the amount of goods 
and of transactions being the same, the value of money is inversely as its 


208 


THE EXPANSION OF ECONOMIC CONCEPTS 


quantity multiplied by what is called the rapidity of circulation. And the 
quantity of money in circulation is equal to the money value of all the 
goods sold, divided by the number which expresses the rapidity of circula¬ 
tion.” ( Principles of Political Economy, Vol. II, Book III, Chapter VIII, 
Sec. 3.) 

This must be the passage that Willis and Edwards have in mind when 
they say: "J. S. Mill, a strong adherent of the quantitative theory of money, 
defined the term money as meaning the volume of money, a term which, 
according to him, could be analysed into two factors, or elements: (1) the 
quantity of money in existence or available, and (2) the rapidity of circula¬ 
tion. This thought he expressed in the well-known formula V=QXR- Of 
course, from this it was fairly to be inferred that if methods of economizing 
the supply of money, or of making it more efficient in circulation, could be 
devised, the tendency would be to raise prices.” ( Banking and Business, 
p. 480.) 

The implication, however, that Mill did not recognize the equally impor¬ 
tant function of credit in its influence on prices is not borne out by the 
facts, as the following quotation will show: 

"But a more intricate portion of the theory of Credit is its influence 
on prices, the chief cause of most mercantile phenomena which perplex 
observers. In a state of commerce in which much credit is habitually given, 
general prices at any moment depend much more upon the state of credit 
than upon the quantity of money. For credit, though it is not productive 
power, is purchasing power; and a person who, having credit, avails him¬ 
self of it in the purchase of goods, creates just as much demand for goods, 
and tends quite as much to raise their price, as if he made an equal amount 
of purchases with ready money.” ( Principles of Political Economy, Vol. II, 
Book III, Chap. XI, Sec. 3.) 

It is seen from the above quotations that Mill saw, at least dimly, all of 
the phenomena that are made so much of by modern exponents of the quan¬ 
tity theory of money. The concepts advanced by Mill, however, have been 
taken by exponents of the mathematical branch of the Neo-Classical econo¬ 
mists and amplified into a widely employed formula. Prof. Irving Fisher has 
probably been most active in this regard. Instead of stopping with the for¬ 
mula V = Q X R he gives the formula: 

MV + M'V' = PT 

in which M stands for the quantity of money, while 
V stands for its rapidity of circulation, and 
M' stands for the extent to which credit is employed, while 
V' stands for the rapidity of circulation of credit, and 
P stands for price level, while 

T stands for volume of trade, or number of exchange transactions. 


MONEY 


209 


According to this way of presenting the subject, prices are entirely pas¬ 
sive—a resultant of the coordination of other forces. 

If the student desires to go further into the mathematical treatment of 
the quantity theory of money let him refer to F. Y. Edgeworth’s Papers 
Relating to Political Economy , Vol. I, p. 195 ff. In this treatment is also 
found replies to Prof. Laughlin’s attack on the quantity theory of money. 

Prof. Gutav Cassel, although a loyal defender of the quantity theory, 
takes exception effectively to the accuracy of the mathematical treatment of 
the subject. To quote: 

"When we pass from the static to the dynamic treatment of the prob¬ 
lem of the dependence of the value of gold upon its quantity, we confront 
difficulties of an entirely new order, and the methods that have hitherto been 
used are not competent to overcome them. Even in our treatment of the 
static aspect of the problem of the value of money we have found that the 
quantity theory is not quite so self-evident as it is sometimes supposed to 
be; that, on the contrary, it is necessary to prop up the theory with assump¬ 
tions, and that these assumptions, though not in themselves improbable, 
require an investigation that lies outside the range of purely theoretical 
treatment and must be based upon the facts of economic life. The resources 
of pure theory are still more inadequate when we turn to the dynamic prob¬ 
lem. What effects an increase of the quantity of money has upon the 
rapidity of circulation of money, the extension of the use of bank media of 
payment, or the proportions of real exchange, and therefore what the ulti¬ 
mate effect upon the general level of prices will be, are questions which do 
not yield to the resources of the theory.” (Social Economy , p. 43 5.) 

Professor Cassel, therefore, practically abandons the deductive approach 
to the problem and attempts to show inductively, i. e., by correlation of 
price changes with gold production that, in fact, prices as a whole have 
tended to rise and fall in response to gold production. A copy of his graph 
is given on the next page. By way of conclusive comment on his study he 
says: 


210 


THE EXPANSION OF ECONOMIC CONCEPTS 


300 

250 

200 

150 

100 

50 

0 

1800 10 20 30 40 50 60 70 80 90 1900 10 

FIGURE 8— CASSEL’S GRAPHICAL PRESENTATION OF THE CORRELATION 
BETWEEN THE PRODUCTION OF GOLD AND PRICES 

-Gold. -Prices 

Cassel’s A Theory of Social Economy, p. 448. 

Courtesy of Harcourt Brace and Company 

"In any case our comparison is enough to prove that during the period 
under consideration (1850-1910) the main cause of the secular variations of 
the general price-level lies in the changes of the relative gold supply, and 
that the quantity theory is right to the extent that the general price-level, 
though it is also influenced by other factors, is directly proportional to 
the relative gold supply. This real connection could not be recognized as 
long as, in comparing the general price-elevel with the gold-supply, writers 
were content with vague surmises about the sufficiency or insufficiency of 
the gold supply. It is only when we settle the idea of the normal gold 
supply that the question of the dependence of the general price-level upon 
the gold-supply has a definite meaning, and the answer is at once given 
by a correct examination of the facts.” ( Social Economy, p. 447.) 

When, however, we compare the price trends as shown in Cassel’s study 
with those shown in the graph given on page 160 we are forced to wonder 
after all whether there is so much in the conclusions based on statistical 
analyses. 

As students of the expansion of economic concepts we are forced to 
acknowledge that the two sides of the controversy are each supported by 
careful students of economic theory and we must in fairness to both hear 






















MONEY 


211 


the arguments advanced by each and if possible find a ground for recon¬ 
ciliation of the two points of view. 

In fairness to the opponents of the quantity theory of money we have 
to admit that their critics have seldom comprehended accurately just what 
they really meant. To show this the following quotations are given: 

"In previous discussions about the effects of inflation one has generally 
looked upon the increase in the quantity of currency as the real cause of 
the rise of prices, and one has declared that the rise in prices must be pro¬ 
portional to this increase in the quantity of currency. This idea is known by 
the name of the quantity theory of money. On the part of theorists this 
theory has been proclaimed as self-evident, but it has always met with 
objections, without the opponents themselves being able to produce a tenable 
explanation of their own. The foremost objection, and the one which lies 
nearest to hand, is that the currency which is put into the hands of the 
public need not remain in the possession of the public, but may at any time 
return to the banks. Ever since the period of inflation in England during 
the time of the Napoleonic Wars, the banks have declared that they cannot 
force upon the public more currency than trade requires, and that the 
banks are therefore in no way responsible for an increase in the quantity 
of the currency. This point of view was also keenly supported by the 
central banks during the years of inflation we are now considering; they did 
not issue more currency than trade demanded. The increased demand was 
explained away by all possible circumstances and amongst others by the 
rise in prices.” (Cassel’s Money and Foreign Exchange after 1914 , p. 26.) 

A more definite and at the same time a somewhat erroneous statement 
of the antithesis to the quantity theory is the following: 

"Accepted as a mere statement that the quantity of money exchanged 
for goods at any given time represents the money value of those goods and 
that therefore prices (the average value of the goods) rise or fall as more 
or less money is required to purchase a given quantity of goods, there need 
be no difference of opinion about it. The only field of controversy in that 
event is simply with reference to factors which may have caused some 
particular elements in the commodity aggregate to rise or fall relative to 
others. For example, let it be supposed that V, the total aggregate of goods 
exchanged for money, consists of a series of different goods, so that the 
quantity theory of money is simply stated as (VI, V2, V3. . . . Vn) equals 
Q XR. Then assume that all but one of the V members making up the 
left-hand side of the equation remain unchanged in their cost and quantities 
of output, but that the remaining member Vn (representing, let us say, 
wheat) has been increased as a result of a bountiful crop and hence has 
been reduced in unit price so that when added to the remaining aggregate 
of commodities the total will exchange in a new relative proportion. With 


212 


THE EXPANSION OF ECONOMIC CONCEPTS 


the problem stated in this way, the question may arise whether the producer 
of wheat who has more gross units but smaller control over money in his hands, 
will be able to purchase as largely of Vl, V2, and so forth, so that as a result 
considerable quantities of these goods may be left on the market and hence 
offered at a lower price in order to transfer them to others who will consume 
them and prevent deterioration which would set in were they held by their 
producers. In this case it may be asked (quantity of money remaining the 
same), may there not have been changes originating entirely on the supply 
side of the price equation which for the time being at least will alter the 
'average’ level of prices.” (Willis and Edwards: Banking and Business, p.482.) 

We have given these quotations at length for the purpose of showing that 
exponents of the quantity theory tend to state merely what they conceive 
might be a logical argument to advance against the quantity theory rather 
than go directly to the opponents and take from them the arguments ad¬ 
vanced. If one limits one’s defences to arguments of his own crtation there 
should be little difficulty in answering them. To avoid any chance of such 
an occurrence in the present discussion we have chosen to quote at length 
from an outstanding opponent of the quantity theory who has relieved 
his discussion of most of the technical terms. With this before us we should 
be able to proceed intelligently to an acceptable conclusion with regard to 
the whole matter. 

"This method of explaining prices emphasizes a fact that is quite obvious, 
namely, that there is a certain relation between the prices of commodities 
and services exchanged for money and the amount of money in circulation, 
the latter phase meaning simply the amount of money exchanged for goods 
and services. When goods are exchanged for money, the sum of their prices 
must equal the amount of money in circulation and neither of these aggre¬ 
gates can change without a corresponding change in the other. 

"As commonly used, however, the quantity theory is made to serve not 
only as a means of making clear this unquestionable fact but of explaining 
the causes of changes in prices. This feature has caused dissent and contro¬ 
versy, and while in an elementary textbook like this a discussion of all the 
pertinent theoretical questions would be out of place, the chief points at issue 
must be indicated. 

"In the first place it should be noted that this theory offers no explana¬ 
tion of the prices of specific commodities and services. This becomes evident 
when we ask how the price of a bushel of wheat, a ton of hay, a ton of 
coal, a pair of shoes, a suit of clothes, a yard of'cloth, and a day’s labor in 
our hypothetical illustration is determined. It indicates merely that the sum 
of the prices of the entire quantity of these goods and services sold on the 
market at one time, however determined, will be one thousand dollars. 


MONEY 


213 


"It is obvious that, as we have shown in the preceding section of this 
chapter, the price of a unit of each item in the above list can only be de¬ 
termined and expressed through the mediation of a standard. Any com¬ 
modity on the list or a day’s labor might serve in this capacity. The figures 
representing the ratios of exchange of the standard with the total quantity 
of each commodity and service on the list when added, would express the 
a Sg re g ate with which the quantity of money in circulation would have to 
be compared. 

"Suppose, for example, that a bushel of wheat is the standard commodity 
and that at a given moment a ton of hay exchanges for 7 bushels, a ton of 
coal for 5, a pair of shoes for 3, a suit of clothes for 19, a yard of cloth 
for 1, and a day’s labor for 2. The figures representing the total value in 
terms of wheat of all the goods and services in the entire list would be 
200 + 700 + 375 + 900 + 475 + 250 + 100 = 3,000. With this latter 
figure the 1,000 money units must be compared and the value of one unit or 

of one dollar, as it was called in the illustration, would be —or 3 bushels 

1000 

of wheat. 

"It, is evident, therefore, that the quantity theory itself cannot be made 
intelligible without the use of a standard of value. Bushels of wheat, tons 
of hay, yards of cloth, pairs of shoes, etc., cannot be added into a total 
with which the quantity of money in circulation can be compared without 
first reducing them to a common denominator through the use of a standard 
of value and there is no way of making intelligible the meaning of such 
phrases as the value of a dollar, the value of a pound sterling, the value of 
a franc, or the value of any other monetary unit except by indicating the 
number of units or fractions of a unit of the standard of value for which 
they are exchanging. As a matter of fact the figures printed or stamped 
on the coins, notes, and other elements of the medium of exchange always 
refer to the standard of value and otherwise would be meaningless. 

"The incompleteness in the respect just mentioned of the quantity theory 
as an explanation of prices cannot be questioned, but this does not con¬ 
stitute the only complaint made against it. It is also alleged that this theory 
fails to reveal some of the most fundamental and important causes of price 
fluctuations. One of these is a change in the value of the standard com¬ 
modity, that is, of the importance people assign to it in comparison with that 
of other commodities, and may be illustrated by reference again to our 
hypothetical illustration. 

"Suppose the community in which these hypothetical exchanges are 
being made should, for some reason (it matters not what) change its estimate 
of the importance to it of wheat as compared with hay, coal, shoes, suits 
of clothes, etc., so that a bushel of this commodity is valued at only half 



214 


THE EXPANSION OF ECONOMIC CONCEPTS 


its former amount. Obviously this change would be indicated on the market 
by doubling the figure that would express the ratio at which it would ex¬ 
change for each commodity and service on the list, and the number that 
would express the total for each and the grand total for the entire list 
would be doubled, that is, for the latter, would be 6,000 instead of 3,000. 
The value of the monetary unit would now be 6 instead of 3 bushels of 
wheat, the figure representing the amount of money in circulation would 
be 2,000 instead of 1,000. Obviously in this case the cause of the change 
in the level of prices is the change in the estimate the community places 
on the worth of wheat, the commodity it has selected as a standard of value, 
the change in amount of money in circulation being a result of this change, 
a mere marking up, or doubling of the figures on the coins, notes, etc., or a 
doubling of the number issued in response to the increased demand created 
by this change. To assign the increase in quantity of money in circulation 
as the cause of this change in the level of prices is like assigning the rise 
of mercury in the tube of a thermometer or a change in the figures on the 
tube as the cause of the change in temperature. 

"It is also alleged that the quantity theory is inadequate as an explanation 
of the price changes that accompany a depreciated currency. By placing the 
entire emphasis upon the quantity of issue the importance of subjective 
causes, which are quite as great and sometimes greater, is left out of account. 

"It is further alleged that this theory is inadequate as an explanation 
of the relation of credit to prices, especially of that form which is manipu¬ 
lated by banks, a criticism the explanation of which must be deferred to a 
later chapter. 

"The position of the critics of the quantity theory is often misunder¬ 
stood by its advocates who allege that the former fail to recognize the 
influence of the quantity of the circulating medium on prices. This is not 
the case. They not only recognize this influence but even assign it the rank 
of a cause, but they do not regard it, together with the quantity of com¬ 
modities offered for sale and rapidity of circulation of money and goods, 
as the only cause of price fluctuation and they explain its influence in a 
manner differing in some respects from that of its advocates.” (Scott: 
Money and Banking , pp. 63-66.) 

From the above it is noted that opponents of the quantity theory do not 
fail to argue that the quantity of money is a cause of the rise or fall of 
prices, but they contend that exponents of the quantity theory err in con¬ 
sidering it the only cause. To that contention Professor Gide has made the 
following genial response: 

"This law, which is called tht quantity theory of money, and the dis¬ 
covery of which is one of Ricardo’s titles to fame, is nowadays very much 
discredited. 


MONEY 


215 


"That is the fate of all so-called classical theories. They begin by being 
admired, but it is soon discovered that they are not sufficiently close to the 
truth, but only rough approximations. Then the critical economist comes 
along and shows them to be totally inaccurate. Such was the fate of the 
famous theory of supply and demand. ... Yet there was something valuable 
in it—so much, indeed, that we can scarcely do without it in current speech. 
And it is the same with the quantity theory of money. No doubt, if we take 
it in an absolute sense, and declare, as we have just done, that prices are 
doubled whenever the value of money is doubled, we run the risk of being 
contradicted by facts, for the quantity of money is only one of the factors 
that operate on prices; there are others also, as we shall see shortly. But 
it cannot be denied that it is at all events one of these factors, and even 
the most important of them. The economist has every right, just as the 
scientific experimenter has, to look at only one of the causes of a phenomenon, 
and neglect all the rest. So, to restore their truth to the formulas we have 
just enunciated, we have only to add the saving clause, 'other things being 
equal.’ And that is how they were understood by the economists who first 
formulated them. They were not so blind as to fail to see that other causes 
also acted on money—not to mention those that act on commodities in 
general—and that they might neutralize each other.” (Principles of Political 
Economy, p. 199.) 

Professor Scott’s allusion to the possibility of change in value of any 
commodity that may be serving as money neglects two important facts, 
namely: (1) the quantity theory assumes the possibility of money having no 
other value than that due to the fact that it is money. In fact that assump¬ 
tion is made by Prof. Scott in his own exposition of the quantity theory. 
To say, therefore, that the value of that commodity may change, in this 
instance, is simply saying that the value of money may change without 
a change in its ratio to goods, a thing that would be quite impossible. 
(2) The value of gold is so nearly completely due to the fact that it is 
used as money that any change in its value from any other source would 
have such a small influence on prices as to be negligible. 

We must conclude, therefore, that the exponents of the quantity theory 
have so much the better of the argument as to make their view the accept¬ 
able one in any orthodox treatise on economics. 

(3) Conventional Money .—Whether or not we accept the quantity 
theory of money we have to accept the fact that it is entirely possible for 
all the functions of money to be performed without the power of converting 
currency into standard money. When that happens we have in operation 
that which has been well called conventional money. 


216 


THE EXPANSION OF ECONOMIC CONCEPTS 


Conventional money assumes two forms, namely, money based on the 
gold exchange standard and fiat money. We shall consider these in order. 

The Gold Exchange Standard .—Before the gold exchange standard can 
be fully understood one must first understand something about foreign ex¬ 
change. It is, however, entirely possible to understand the conventional aspects 
of it without intimate knowledge of foreign exchange. 

It grows out of an arrangement which makes it the practice for the 
currency of a nation to be redeemable in foreign exchange which in turn 
gives credit against a gold deposit in another nation. The fact that the local 
currency may command exchange which in turn may command gold in 
international trade gives currency a gold valuation in spite of the fact that 
it may never actually command the gold. Fluctuations in exchange rates so 
influence the supply and demand for money as to prevent its value from 
varying between very wide points. 

The gold exchange standard is a result of a conscious policy of govern¬ 
mental control of the value of money in some of the less civilized countries; 
but the experiences with it have made us wonder whether or not the govern¬ 
ments of the world, if they seriously attempted it, could not really establish 
a currency with a stable value. 

It has in the past usually come in countries which have been previously 
worrying along with the silver standard. Upon the establishment of the gold 
exchange standard the free coinage of silver is stopped; any further coinage 
of silver is done only for the government. A legal ratio is established at 
which silver is legal tender along with gold. The purpose of stopping the 
coinage of silver is to starve the country for currency for a while, while the 
population and trade grow and demand for money increases until the value 
of silver coins exceeds the value of their silver content and depends upon 
its power to buy foreign exchange. The power to buy foreign exchange will 
keep silver coins from the melting pot. 

Preparatory to this a gold standard reserve fund has been established 
in another country with which to redeem silver currency in drafts on the 
country holding the gold reserve. The funds may be kept as ear-marked gold, 
or at least in liquid form. Against this reserve the government in the original 
country stands ready to sell exchange at a price equivalent to the gold export 
point. In the country holding the gold the authorized agent of the other 
country stands ready to sell exchange on the other country at the gold 
export point. 

When exchange rates in the first country rise to the gold export 
point, the government, in exchange for silver coins, gives the would-be 
currency exporter a draft on the gold-holding country, and charges him 
simply what it would cost him to ship that amount of gold were he to 


MONEY 


217 


export gold bars. This prevents the exportation of gold; it removes from 
circulation an amount of the redundant silver coins equal to the purchase 
price; and the scarcity of money then tends to lower the exchange rates. 

On the other hand when exchange in the gold-holding country reaches 
the gold export point, an authorized agent of the other country, in return 
for regular currency of the gold country paid into the gold standard reserve 
fund there, gives a would-be exporter of gold drafts payable in the silver 
country, the price asked being simply enough to cover the cost of shipment 
of gold if gold were to be exported. When these drafts are cashed an 
equivalent amount of silver currency is put into circulation. 

The interesting thing for us at this point is the fact that under the 
gold exchange standard there is no gold in circulation. The currency supply 
is adjusted quite automatically to the demands of trade. Gold values, how¬ 
ever, are in the background. They effectively serve to keep the silver currency 
on a parity with gold. The money, however, is conventional money, since 
its value is really due to a conscious governmental plan of operation. 

Fiat Money .—Almost an exact counterpart of the gold exchange standard 
is that of fiat money. The gold exchange standard comes as a result of a 
strong governmental policy. Fiat money has always come as a result of a 
financial policy of a weak government. Whether or not a strong government 
could arbitrarily operate a definite policy of stablization of the value of its 
circulation media without the reenforcing power of some valuable commodity 
behind it remains to be seen. The fact is that experiences with fiat money in 
the past throw little light on the proposition. 

Whether or not we accept the quantity theory of money, the fact re¬ 
mains that an increase in purchasing power without a corresponding increase 
in the volume of goods and services is bound to have a disturbing influence 
on the level of prices. The conscious policy of the govemnment to keep the 
value of money at par with the value of gold has a steadying influence on 
prices. If the value of gold should remain constant, and if the government 
were successful in keeping the value of the currency at a par with gold, 
we should not have the disturbing influence of general price variations. 
If the government could find a way consciously to nullify the changes in 
the value of gold at the same time that it maintained the gold standard 
the problem of price stabilization would be solved. Realization of this fact 
has been fruitful of many suggestions for the establishment of a superior 
monetary system. 

Were it not for the widespread misunderstanding of just how far the 
government can go in the provision of a monetary standard, very little 
space would need to be given to the subject of fiat money. The fact is, 
however, that there are many otherwise intelligent people who hold the 


218 


THE EXPANSION OF ECONOMIC CONCEPTS 


opinion that the government can give value to a thing simply by stamping 
on its face that it is worth a certain amount. There are several preliminary 
considerations that need attention before analyzing the theory of fiat money. 

(1) The Resort to Money Has to Be Spontaneous .—We have already 
explained Adam Smith’s theory of the origin of money. After one society 
has learned the secret it can be conveyed to another. Then, possibly, a 
monetary system might be imposed from the top. But the employment of 
some one commodity as money begins and grows with trading. The money 
phenomenon comes into existence apart from an act of government. 

(2) The Unit of Trading Has to Have a Meaning .—It is hard to see how 
a government could arbitrarily invent a standard monetary unit. The 
dollar, the franc, mark, pound, etc., have to mean something originally and 
in relation to one another. Fortunately, or unfortunately, it does not have 
to retain its original meaning. If it did most monetary units would convey 
an idea different from what they are today. It is possible for the government, 
however, to designate an entirely new monetary unit. That, of course, has 
been done many times. But each time the name selected has originally meant 
so much of a certain valuable commodity. We have seen that practically all 
of the different units have come to designate a known amount of gold. 
The value of one money in terms of another, therefore, is simply the ratio 
of the number of grains of gold in the one to that in another. 

(3) After People have become Habituated to the Use of a representative 
or fiduciary money, it is possible for a subterfuge to perform some of the 
functions of money .—It is here that we encounter the phenomenon of fiat 
money. Fiat money appears when the government issues paper money and 
makes it legal tender in spite of the fact that it cannot be redeemed in specie. 
As we have already noted it has always made its appearance in times of great 
stress. 

The economic weakness of fiat money is comparatively easy to com¬ 
prehend. Every payment that is made, whether made by the government or 
by an individual, to be economically sound, must be made in exchange for 
an equivalent value. Whenever, therefore, anyone who possesses articles of 
value is forced to give them up without receiving in exchange an equivalent 
value he has lost the difference. Now, when the government issues fiat money 
it uses its superior power to force persons to relinquish their valuable com¬ 
modities without giving them equivalent values in exchange. It, however, 
attempts to cure the wound by giving the persons from whom the goods 
have been taken the means by which they can do the same thing for other 
people. Through this means they are supposed to be able to regain their loss. 


MONEY 


219 


It may be argued, however, that in levying a tax, the government does 
a similar thing. When one pays his taxes he gives up a certain amount of 
purchasing power without receiving anything definite in return. This argu¬ 
ment, however, is aside from the point. When one pays one’s taxes one con¬ 
tributes, supposedly, according to some equitable plan of apportionment, his 
share to the maintenance of the government. His wealth, in fact his very 
existence, may be traceable to the fact of the established government. He is 
certainly, therefore, not giving something for nothing. 

Yet that fact is not the major one in considering the difference between 
paying taxes and exchanging goods for fiat money. When one pays taxes he 
surrenders a part of his purchasing power. The total purchasing power is in 
no way increased by the act of paying taxes. When the tax payer surrenders, 
money to the government, the government spends it instead of the taxpayer. 
The collection and spending of money through a well-ordered system of taxa¬ 
tion and public expenditure in no way seriously interferes with established 
values. When the government, therefore, spends money that has been raised 
by taxation, it spends money that would have been spent anyway. No serious 
disturbance of established values need occur. But when the government puts 
out new issues of paper money—money that has not been collected from the 
existing supply—it does disturb established values. All of the existing money 
still remains in the hands of the people and is spent as usual. In addition a 
new volume of purchasing power flows into channels of trade. A demand 
for goods comes into existence which did not exist before. Prices, therefore, 
begin to rise. This usually happens at a time when the productive agencies 
are also handicapped and goods are of necessity somewhat short. If the process 
of issuing fiat money continues, and when once begun it usually does continue 
for the very fact of fiat money and rising prices stimulates the issues of 
larger and larger amounts of fiat money, prices may rise to any point. Yet 
in spite of the fact of the now universally recognized danger of paper fiat 
money, whenever governments find themselves in dire straits they invariably 
resort to the expedient and hope for the best. 

(4) In Spite of the Unfortunate Experiences in the past with fiat money , 
the fact that the gold exchange standard has been successfully operated , makes 
us wonder whether or not conventional money might not be successfully 
employed to prevent widespread fluctuations in prices. 

The gold exchange standard successfully maintains the value of money 
at a parity with gold without gold itself circulating. If something in the off¬ 
ing could function for all moneys as does gold in a foreign country for the 
country of the gold exchange standard, and if that something could be of 
constant value then the trick would be turned. What that thing might be 
is of course the enigma. It has been suggested that it might be an abstract. 


220 


THE EXPANSION OF ECONOMIC CONCEPTS 


concept—namely purchasing power. Just as the term horse-power in me¬ 
chanics no longer means anything except an abstractly predetermined lift, 
so the term purchasing power might be an arbitrarily predetermined power of 
acquisition of goods and services. The term horse-power must have originally 
had some relation to the strength of a horse, just as the term dollar meant 
the buying power of a certain amount of gold. Yet just as the term horse¬ 
power has been fixed at a certain amount so the term dollar could be thus 
fixed—probably not quite as accurately but nearly enough. Then the supply 
of money might be forced to expand or contract around the concept of 
purchasing power much as the volume of currency expands and contracts 
under the gold exchange standard. 

A plan of this kind might in fact be worked very simply. A well-kept 
system of index numbers would give a fairly accurate measure of the varia¬ 
tion of prices from any established norm. The percentage of variation could 
be taken as a measure of the amount to vary the circulating media. The 
adjustment to conform to the measure of constant value as discovered 
through the use of index numbers could be made through the use of govern¬ 
ment bonds. The currency could be contracted through the issue of bonds 
and expanded through the payment of bonds. These devices are not at all 
unfamiliar. As is shown in a later chaper, international trade adapts itself 
as readily to purchasing-power parity as it does to mint pars. In addition 
with a controlled currency the world would be relieved of the disturbances 
of price levels due to the international flow of gold. 

Conclusion. —Up to this point we have been concerned with the nature 
and functions of money. We have attempted to show something of how the 
problem of money has been handled by outstanding authorities. In con¬ 
clusion it will probably be helpful to bring to a focus the different points 
developed in the preceding pages. 

1. The Functions of Money to be clearly understood have to be sub¬ 
divided into (1) the private functions and (2) the social functions. 

The distinction between private and social functions is highly important, 
though seldom if ever recognized in treatises on money. It is clearly evident, 
however, that money may be entirely good in private transactions and yet 
highly inefficient socially. In fact it is comparatively easy to establish a 
satisfactory money, privately speaking, but not so socially speaking. An 
illustration of money that was perfectly good in the hands of the private 
citizens was that of our National Bank Notes. Socially, however, they were 
far from satisfactory. 

The private functions of money are: (1) medium of exchange, (2) 
simplification of ratios, and (3) store of value. 


MONEY 


221 


The medium of exchange function is apparent in the superiority of money 
economy over barter. In trading, the straight line is not the shortest distance 
between two points. It is more expeditious to exchange valuable commodities 
for money and thereupon employ the money to secure other goods than it 
is to trade directly goods for goods. 

The employment of one commodity in terms of the value of which other 
values are quoted reduces to the simplest terms the valuation process. Prob¬ 
ably no other invention has been more beneficial to mankind. 

"It should be observed that in exchange in the form of barter the estima¬ 
tion of value is uncertain, and this gives rise to exploitation of the worst 
kind. In trading with the natives of Africa, if you give the negro guns or 
calico in exchange for rubber or ivory, the purchasing commodity is counted 
at four times its value, and the value of the produce bought is halved so 
that the European gets eight times as much as he gives. That, however, is a 
fair rate: in many cases 1:100. The introduction of money is a blessing in 
this respect; it has been an instrument of justice and morality.” Gide: 
Principles , p. 188.) 

The store of value function is characteristically a private function of 
money. Society as a whole is not interested in the store of value but is instead 
interested in the elimination of value. The durability of a good, however, 
is sometimes essential to the successful storing of value. When the good is 
at the same time durable while its value remains also unaffected by time 
the social and private functions conform. That, however, is more char¬ 
acteristic of hoarding than it is of saving. The store of value in its private 
significance is rather that of enabling the individual to retain a certain 
amount of purchasing power, without loss, for use at a future date. Savings 
institutions are making that increasingly possible. The change in purchasing 
power is, however, still a characteristic of money regardless of anything 
that has been done in the history of money. 

The social functions of money are: (1) measure of value, and (2) 
facilitation of production and distribution. 

The measure of value function clearly resembles that of the simplification 
of ratio. Goods and services, as we have seen, have two sorts of exchange 
value, namely, market value and normal value. It is through the phenomenon 
of money that we are able to discover the variation of market value from 
normal value. Were it not for the fact of the variation of the market value 
from normal value money could much more readily serve as a measure of 
value. It does at the same time, however, furnish us with a gauge to ascertain 
whether or not there is a variation of market value from that of normal 
value and for the determination of normal values. 

Whenever, however, the market value of any good or service does vary 
from the normal value almost automatically forces are set into motion to 


222 


THE EXPANSION OF ECONOMIC CONCEPTS 


dissipate that variation. The phenomenon of a high price calls attention to the 
need of acceleration of production of certain goods. The phenomenon of a 
low price calls attention to the fact that productive agencies have unduly 
multiplied other goods. Money, therefore, serves as a sort of barometer for 
the determination of what goods need to be produced more or less abundantly. 
Thus production, distribution, and consumption are kept somewhere near 
the normal relationship. 

At this point the author wishes to mention again that the standard of 
deferred payment does not commend itself to him as a separate and distinct 
function of money. A perfect measure of value would measure future values 
as well as present values. 

2. Money Classified .—A satisfactory classification of money should adapt 
itself to every aspect of money. It should be possible to employ it for the 
purpose of identifying the types of money of any nation in the past or 
present. One should be careful, however, not to include in the classification 
anything which cannot logically be considered as money. 

The following classification of money is given with the thought that it 
may help to clarify in the mind of the reader the whole subject: 

(1) Standard money. 

a. Full-bodied. 

(a) Economic goods other than the metals (such as cattle, beads, etc., char- 
teristic of primitive man). 

(b) Metallic money (gold, silver, or other precious metal. Usually only one 
metal is selected, but sometimes two). 

b. Conventional money (standard established by governmental decree). 

(a) Fiat money. That which comes into existence by legal tender acts during 
periods of financial distress. 

(b) The gold exchange standard. In contrast with fiat money this comes as 
a result of a strong governmental policy. 

(c) Arbitrary standard. As yet untried but several different suggestions for 
it exists in economic literature. 

(2) Fiduciary money—all other forms of money except the standard. 

a. Government notes. Ideally government notes should circulate merely instead 
of the standard money. In practice, however, government notes are frequently 
issued in excess of the reserve. In our own currency the government notes are: 

"Greenbacks,” Treasury Notes of 1890, and gold and silver certificates. 

b. Bank Notes. It requires no little thought to comprehend the logical place of 
bank notes as a circulating medium. In all progressive nations bank notes are 
given the character of money. In our own currency we have the National Bank 
Notes, the Federal Reserve Bank Notes, and the Federal Reserve Notes. There 
is really no need for any except the last. 

c. Fractional currency. This supplies the "small change”. It usually takes the form 
of copper, nickel and smaller silver coins. 

Other media of exchange than those included in the above classification 
must be considered as belonging to credit. That subject is before us for con¬ 
sideration in the next chapter. 



Pierre-Joseph Proudhon ( 1809 - 1865 ) 


"Other writers had sought a solution in the complete overthrow of the present methods 
of production and distribution. But Proudhon thought it lay in improved circulation. It was an 
ingenious idea, and deserves mention in a history of economic doctrines because of the truth, 
mingled with error, which it contains, and because it has become the type of a series of simi¬ 
lar projects.”—Gide and Rist, Hist, of Economic Doctrines , p. 291. 

When one first contemplates the nature of pure credit one is most likely to attribute it 
to the characteristics given in such a forceful way to it by Proudhon. The author knows of 
no better exercise in some of the most abstruse aspects of economic theory than to show the 

223 









224 


THE EXPANSION OF ECONOMIC CONCEPTS 


inaccuracies of Proudhon’s exchange bank notes in respect to (1) their difference from the 
bank notes of actual circulaton; (2) the difference between bank discount and pure interest; 
(3) the distinction between credit and capital; and (4) why the extent to which credit makes 
money payments unnecessary can never go so far as to provide everyone with unlimited pur¬ 
chasing power. In treating of that subject, however, Proudhon was grasping after a force which 
even now is far from clearly understood by very many of the most serious students of the 
social sciences. 

"The work which brought Proudhon to the notice of the public was a book published in 
1840 entitled Qu’est-ce que la Propriete? Proudhon was then thirty-one years of age. Born 
at Besangon, he was a son of a brewer, and was forced to earn his living at an early age. He 
first became a proof-corrector, and then set up as a printer on his own account. Despite hard 
work he became a diligent reader, his only guide being his insatiable thirst for knowledge. 
The sight of social injustice had sent the iron into his soul. Economic questions were faced with 
the ardour of youth, with all the enthusiasm of a man of the people speaking in behalf of his 
brothers, and with all the confidence of one who believes in the convincing force of logic 
and common sense. All this is very evident in his brilliantly imaginative work. Mingled with 
it is a good deal of that provoking swagger which was noted by Sainte-Beuve as one of his 
characteristics, and which appears in all his writings.”— Ibid., p. 292. 


CHAPTER XI 


CREDIT 

In the opinion of the writer the following quotation from John Stuart 
Mill is as true today as it was when he wrote it: 

"The functions of credit have been a subject of as much misunderstanding 
and as much confusion of ideas, as any single topic in Political Economy. 
This is not owing to any peculiar difficulty in the theory of the subject, 
but to the complex nature of some of the mercantile phenomena arising from 
the forms in which credit clothes itself; by which attention is diverted from 
the properties of credit in general to the peculiarities of its particular form/’ 
(Principles , Book III, Chap. XI.) 

Among surprisingly few authors has an effort been made really to dif¬ 
ferentiate and refine the concept of credit as distinct from its concomitant, 
that of capital. Occasionally we find an allusion to the fact that the subject 
requires careful differentiation, as is evident in the following: 

"In the history of economic doctrines, we must distinguish three main 
types of views regarding credit. 

"1. In the first group come the opinions of those who confounded a 
necessary precondition of credit with its true essence. Thus, some declared 
credit to be the 'confidence 5 or a 'frame of mind 5 of the creditor, or a 
'capacity 5 of the debtor. Cf. James Steuart ( Inquiry into the Principles of 
Political Economy , 1767), J. B. Say, K. H. Rau ( Grundsatz der 'Volksunrt- 
schaftslehre, eighth edition, 1868.) Nebenius, Hildebrand, etc. Others have 
considered credit to be 'a postponement of payment, 5 as for example, Man- 
goldt (Volkswirtschaftslebre, 1868). But it is different if the 'confidence 5 be 
merely the expression of the new economic community between lender 
and borrower! 

"2. Coming to the second group, we find John Stuart Mill, criticising 
such views as those just epitomised, wrote accurately enough: 'Credit 5 is 
'only permission to use the capital of another person; 5 and 'Credit is but a 
transfer from hand to hand 5 ( Principles of Political Economy , Book III* 
Chapter II, p. 81). Dietzel, and many other authorities, wrote in a like strain. 
Such a way of formulating the notion is not erroneous; but it is unduly 
mechanistic, and it ignores, not only the new and more fruitful community 


225 


226 


THE EXPANSION OF ECONOMIC CONCEPTS 


which credit establishes, but also the second act, the payment that is to be 
made at some future time. Nevertheless, this second act is of great im¬ 
portance, inasmuch as the demand for payment can enter into the monetary 
circulation vicariously, as if it were actual payment. Knies holds a similar 
view . . . for he refers, not only to the transference of capital, but also to 
the time factor. Bohm-Bawerk writes in a similar strain. 

*'3. To the third group belong Law and Macleod, who do not regard 
credit as a transference of capital, but look upon the debt itself as a peculiar 
kind of immaterial capital, as an independent 'additional’ or 'supplementary’ 
capital.” (Spann: The History of Economics, p. 73.) 

Although the above comments are suggestive, we must observe that the 
concluding remarks (not quoted) of Professor Spann are far from a clear 
exposition of the nature of credit. 

The Characteristics of Credit. —Modern economic literature generally 
gives four outstanding characteristics of credit. They are: (1) confidence, 
(2) futurity, (3) contract, and (4) price. Now the author concedes that 
three of the above are essential to credit. We are unable to see, however, that 
the element of futurity is essential to credit. In fact the element of futurity 
relates to an entirely different thing both in the popular and the scientific 
use of the term credit. The element of time relates to capital as distinguished 
from credit. 

We have found only one contemporary authority who has called attention 
to the fact that futurity is not essential to credit and unfortunately this 
one went only a short way in the direction of isolating pure credit from 
its concomitants. The following quotation is given from that authority: 

"A means of further safeguarding the definition might be found by in¬ 
troducing the so-called time element and regarding credit transactions as 
those that are closed only after the lapse of a certain length of time. Indeed, 
many writers on the subject regard the time element as the essential or char¬ 
acteristic feature of credit. This does not seem to be a well-warranted view 
of the case. As will be seen at a later point, many transactions which result 
in an immediate closing of obligations contain no element of time, as, for 
example, when A purchases goods from B and pays B with a check on his 
bank. This, as will be seen in later pages, is unmistakably a credit transaction. 
Yet it involves no postponement of settlement as between A and B. Recog¬ 
nizing the possible difficulties to which the definition is thus open, the idea 
of credit as a system of indirect exchange without money—hence at any 
given moment uncompleted exchange—is accordingly adhered to.” (Willis 
and Edwards: Banking and Business, p. 10.) 

Professor Gide, however, sensed the difficulty of including the time 
element as an essential of credit, for he says: "The cheque is not, strictly 


CREDIT 


227 


speaking, an instrument of credit; it is an instrument of payment.” (Political 
Economy , p. 325.) 

Since the check is certainly not money, and since the only other instru¬ 
ment of payment than mony is the credit instrument we must take issue 
with Prof. Gide and recognize once and for all that the time element is not 
essential to credit. 

Since credit makes it possible for exchanges to be completed without 
money it becomes necessary that we provide safeguards lest we confuse it 
(1) with barter and (2) with postponed payment. It is in connection with 
the second that we discover the difference between credit and capital. In 
connection with the first we find the phenomenon of the credit circle. 

Credit Distinguished from Capital .—In making the distinction between 
credit and capital it is necessary for us to presume on the knowledge of 
the student a little. The treatment of capital in this study comes later. We 
may say here, however, that capital is the value of the products which have 
been set aside for the furtherance of production. There is a point of time 
in the transition from invested capital through money, or credit, into new 
uses when the decision has to be made whether income will be utilized for 
other investments or for consumptive purposes. It is here that the time 
element appears. If capital did not have the faculty of providing a source 
of independent incomes it is seriously to be doubted whether or not its supply 
would be well conserved. It is that future income from capital that con¬ 
stitutes the reward for saving. Credit is preeminently an exchange of present 
values. These present values may be capital values or they may be con¬ 
sumable values. If capital values, credit may serve to give persons command 
of capital goods who might not otherwise secure them. But the service of 
providing capital to those who do not have it is a "spot” transaction. The 
payment for that service should be distinguished from that of an interest 
charge. In actual practice the charges are readily distinguished and in many 
places clearly differentiated. 

The Credit Circle .—The fact that credit makes it possible for ex¬ 
changes to be made without money gives rise to the need of another caution, 
as noted. A careful distinction must be made between credit and barter. 
Barter is the least facile of all types of trading, while credit is the most 
facile. At the same time credit very clearly brings us back to barter. To 
see this clearly we need to understand the phenomenon of the credit circle. 

The following neat illustration of the nature of the credit circle once 
came to the attention of the writer. A student in college purchased a haircut 
from the campus barber and paid for it with a lead half-dollar. The barber, 
not noticing that the coin was counterfeit, purchased cigars with it from a 
near-by cigar store. It happened that the student was employed in the store 


228 


THE EXPANSION OF ECONOMIC CONCEPTS 


from which the barber purchased the cigars. The manager of the cigar store 
returned to the student the counterfeit coin as part compensation for his 
work. It takes very little thought to see that the student worked for his 
haircut. It is not easy to see, however, that although the above illusration 
is typical of the credit circle it was not genuinely so. It happened, however, 
that all of the phenomena of credit were present except one. There was price, 
also confidence, even though it was only one-sided. There was, however, no 
evidence of a contract. In fact the transaction assumed the aspect of a 
cash one. Had the student given to the barber an order on the cigar store 
to allow the barber to have goods valued at fifty cents and to take it out 
of his pay, then the transaction would have possessed all of the elements 
of a credit transaction. It would have been a credit circle. For the trans¬ 
action to take the form of credit there can be no assumption of cash but 
instead a balancing of values through some form of contract that makes 
the employment of money unnecessary. 

The two outstanding aspects of the credit circle have well been illustrated 
by J. S. Mill as follows: 

"First: Suppose A and B to be two dealers, who have transaction with 
each other both as buyers and sellers. A buys from B on credit. B does likewise 
with respect to A. At the end of the year, the sum of A’s debts to B is set 
against the sum of B’s debts to A, and it is ascertained to which side a 
balance is due. This balance, which may be less than the amount of many 
of the transactions singly, and is necessarily less than the sum of the trans¬ 
actions, is all that is paid in money; and perhaps even this is not paid, but 
carried over in an account current to next year. A single payment of a 
hundred pounds may in this manner suffice to liquidate a long series of 
transaction’s, some of them to the value of thousands. 

"But secondly: the debts of A to B may be paid without the interveption 
of money, even though there be no reciprocal debts of B to A. A may satisfy 
B by making over to him a debt due to him from a third person, C. 
This is conveniently done by means of a written instrument, called a bill of 
exchange, which is in fact, a transferable order by a creditor upon his debtor, 
and when accepted by the debtor, that is authenticated by his signature, 
becomes an acknowledgment of the debt.” ( Principles of Political Economy , 
Book III, Chapter XI, Sec. 3.) 

As we have seen, therefore, although credit very nearly brings us back to 
barter yet it is not exactly barter. The employment of credit instruments 
makes it possible for dealers in credit, through the intervention of those 
instruments, to match one obligation against another easily and freely without 
the parties whose obligations are matched necessarily being aware of it. This 
matching of obligations without the use of money is essential to all credit 
transactions. 


CREDIT 


229 


Definition of Credit. —In contrast with the subject of money the books 
are full of definitions of credit. As we have noted, however, the inclusion 
of the time element in most of these definitions makes them logically in- 
acceptable. Among all the definitions of credit seen by the author only one 
approximates a satisfactory one. That is given by J. S. Mill as "a distinct 
purchasing power, independent of money.” (Page 54, Vol. II.) In other 
places where we have found a recognition of the fact that futurity is not 
essential to credit we have not always found a satisfactory definition. 

Two definitions seem to compete with each other for acceptance. The 
one (just given) is that of exchange transactions merely without the use 
of money, and the other is that of an uncompleted exchange. Willis and 
Edwards define credit as a suspended or uncompleted exchange. This latter 
definition is clearly inaccurate for if an exchange transaction is incomplete 
the element of futurity is of necessity recognized. 

Since we can think of only two sorts of exchanges without the use of 
money that do not conform to the characteristics of credit—namely, those 
made possible by the use of counterfeit money and those growing out of 
barter—we can possibly best define credit as exchanges in terms of money 
without the use of money and devoid of deceit. The phrase in terms of money 
eliminates barter, whereas the phrase devoid of deceit would seem to eliminate 
exchanges that are made possible by the employment of counterfeit money. 

It might be suggested, however, that under this definition the expression 
credit money would lose its meaning. It was to avoid this contradiction that 
we spoke of other forms of money than standard money as fiduciary or 
representative money instead of as credit money. If, however, for the time we 
limit our concept of money to that of standard money, then fiduciary or 
even representative money would logically become credit money. Some 
persons who have sensed this difficulty have limited their concept of money 
to that of standard money and employ the term ’'currency” to indicate 
something half way between credit and money. It is probably best, in the 
end, to let the term money apply to all means of payment that pass without 
question in exchange transactions and include currency in the concept of 
money. Then if we think of credit as being exchanges without the use of 
money (with the exceptions noted) it is a very simple matter to carry the 
concept of credit into the distinction between fiduciary, or representative* 
money and standard money. 

Classes of Credit. —Before attempting a classification of credit we 
should decide upon a logical basis of classification. The following two bases 
seem to be the most helpful: (1) uses, and (2) duration. 

According to use there are three main distinctions to keep in mind with 
regard to credit. They are: (1) personal v. business credit; (2) mercantile v. 


230 


THE EXPANSION OF ECONOMIC CONCEPTS 


bank credit; and (3) public v. private credit. Needless to say, these overlap. 

Personal as distinguished from business credit is seen when the interest 
served is merely that of an individual. Just what percentage of the credit 
transactions never reach beyond the personal stage will probably never be 
known. It is certainly true, however, that with the perfection of credit in¬ 
stitutions the amount of personal credit employed has been materially reduced. 
Our illustration of the student and his haircut above would have been typical 
of personal credit had it been genuinely a credit transaction. The reader can 
readily think of many other similar illustrations. Business credit is somewhat 
more formal. Something more than a mere trade appears. There is a hope 
to gain by the transaction. We find evidences of business credit all about us. 

Mercantile as distinguished from bank credit might be considered as sub¬ 
divisions of business credit. Merchants resort to credit for business purposes. 
With banks, credit is their business. Since that is true, business men other 
than bankers very seldom make it their practice to carry their own paper. 
They can usually make more with the money than they can by merely 
realizing the profits from the credit transactions. For that reason it becomes 
the practice of business men to "turn their paper.” There is, however, always 
a certain amount of mercantile credit which never gets into banks. The 
retailer, for instance, might conceivably employ due bills, given him by his 
customers for purchases made, in payment for merchandise purchased from 
wholesalers. The wholesaler might in turn employ these same due bills to 
cover obligations to jobbers, or manufacturers. The manufacturer might 
in turn conceivably return certain of the due bills to the self-same customers 
now appearing as workmen in the factories. This, of course, is a strained 
illustration and inaccurate because of the failure to recognize the presence 
of gains made by each participant in the circle. It may be helpful in making 
clear, however, that business transactions might neutralize one another with¬ 
out the intervention of either money or of the banks. Owing to the difficulty 
of bridging the gap, between the various interests represented, the phenomnon 
of bank credit appears. Banks are institutions that facilitate exchanges by 
means of credit. In banks, credits are so pooled that obligations can con¬ 
veniently be matched. It is even conceivable that, under a perfectly co¬ 
ordinated system of banks, money payments could be entirely dispensed with. 
Under the established systems of checks and drafts, pyramiding in clearing 
houses, as it is, practically all of the major business transactions are now 
handled without the use of money. It is because of that fact that the modern 
era is spoken of as the credit era. 

Public credit as distinguished from private credit involves the widest 
distinction in relation to credit. All of the aspects of credit previously treated 
in this classification belong to that of private credit. Public usually takes 
the form of loans to the government. The exact nature of public credit, 


CREDIT 


231 


however, is more illusive than other forms of credit. The size of the govern¬ 
ment debt is usually taken as a measure of the extent of the employment of 
public credit. The act of borrowing, whether done by the private individual 
or by the government, is logically a credit transaction. When one borrows 
one resorts to credit. One may in fact borrow money, but seldom is it true 
that one does borrow money. The prime purpose is to dispense with the 
need of money by gaining a control over a certain amount of capital in 
return for a promise to pay back the loan with enough in addition (interest) 
to make it attractive for the owner of the capital to part with it during 
the interval of the loan. Presumably the borrower’s promise to pay (including 
the loan and the interest) is equal in value to the present worth of the 
capital loaned. The exchange is of necessity made in terms of money and is 
made by credit agencies who charge for their services. Now, government 
borrowing is not materially different in purpose from that of individual, or 
private, borrowing. What the government wants is the command of a 
certain amount of the limited supply of capital, if possible, without material 
disturbance of the money supply. Government loans, therefore, are a com¬ 
posite of portions of individual accumulations of capital which have been 
surrendered to the government in return for the government’s promise to 
return them with interest at a future date. If the government utilizes the 
capital as economically as would have been done by the private interests who 
surrendered it, the net income will be made available much as in the case 
of private loans. Values as a whole would not be materially disturbed. 

All too frequently, however, the government does not use the capital 
productively. In time of war, particularly, the capital itself is frequently 
destroyed and with it goes its net yield. This loss of capital naturally reduces 
the social income and makes goods generally more valuable. At the same 
time the government bonds are frequently given the character of representa¬ 
tive money."' Thus the total supply of money is increased at the same time 
that the total social income grows less. Thus the result of government loans 
is to cause prices to soar. Everybody, more or less, experiences a loss in income. 
All too frequently, therefore, the use of government credit introduces an 
agency for the expansion of the money supply without a corresponding 
expansion of the amount of money-work to be done. 

These observations, however, do not relate to the use of government 
credit for industrial purposes. The capital thus secured may, and usually 
does, yield an income that goes to swell the wealth of the whole nation. 
Even though government bonds thus employed may be instrumental in ex¬ 
panding the money supply, yet the corresponding expansion of production 
neutralizes its harmful effects. Values are not materially affected—at least 
prices are not raised thereby. 

*For instance, Federal Reserve Bank notes as based on government bonds. 



232 


THE EXPANSION OF ECONOMIC CONCEPTS 


Another way to classify credit is according to duration. In connection 
with this plan of classification we find the appearance of credit instruments. 
Here we have (1) short time or commercial credit; and (2) intermediate 
or operative credit; and (3) long-time or investment credit. Each of these 
grand divisions has several subdivisions. For instance commercial credit sub¬ 
divides into informal and circulation; intermediate, credit while primarily 
agricultural, appears also in the purchase of homes and to some extent in the 
industries; and investment credit has many different forms. Each has its 
parasite—speculative credit. 

Commercial Credit .—The contract of credit that matures within a period 
of six months and is expected to be discharged from the proceeds of the 
exchange transaction made possible by the use of credit is here referred to 
as commercial credit. We have noted that it falls into two distinct groups. 

(1) Informal Commercial Credit.—The type of credit here referred to 
seldom carries a definite charge for the fact of futurity. It varies all the 
way from oral agreements to return a loan or pay an account within a few 
days to widely used book accounts. It is frequently referred to as unsecured 
credit. Nothing definite rests in the hands of the creditor which he can put 
up and sell in case the advance is not covered when due. Although no charge 
is regularly made for this kind of advance yet the charge is certainly there. 
At least the creditor is conscious of an average percentage of loss and adjusts 
his price to take care of that. He may speak of it as charging the honest 
man for the unpaid bills of the dishonest. But even if no chance of loss 
existed the advance of a present value in return for a promise to pay in the 
future—the fact that the exchange is to be completed at a future date— 
would of necessity give rise to a slight charge. The charge may take no 
other form than that of a discount for cash. Yet the discount for cash simply 
means that an interest charge has been made in the process of setting the 
price. It does not take an expert to calculate that even a slight discount 
of, say, two per cent is sufficient not only to cover any likely amount of 
interest as well as something for the extension of credit. 

(2) Circulating Commercial Credit.—The term circulating in connection 
with credit has been employed to convey several different concepts. It is 
employed here in the sense which appears to the writer to be most logical 
The passage of commodities from one place to another is almost universally 
spoken of as circulation of wealth. That is done because of the fact that the 
term distribution is used in an entirely different sense—that of the subdivision 
of the income. Now when credit is employed to facilitate the circulation of 
goods it would seem that it should logically be called circulating credit. 
It is thus called here. 


CREDIT 


233 


It refers to those forms of credit instruments that float away from the 
creditors and debtors and complete few or many credit circles before they 
float back. The most widely known of these is the check or draft. Since 
no element of time exists in connection with these they are almost if not 
entirely a pure credit phenomenon. Whenever the element of time appears 
the values are balanced by the addition of an interest charge, as well as some¬ 
times a carrying charge. Thus a promissory note can complete credit circles 
as readily as can a check or draft. 

Illustrations of commercial credit instruments which involve the element 
of time are comparatively easy to find. They belong to the big volume of 
credit instruments known as "commercial paper.” To these belong time drafts, 
promissory notes, trade acceptances, frequently bank acceptances, etc. The 
operation of a transaction handled with commercial paper is easily described. 
The problem is that of merely bridging an interval of time. A merchant may 
be doing, say, a sixty-day business. He may have accounts due from sales 
but at the same time he may be short of working capital. Unless he can find 
some way to secure funds to tide him over the period until he can make 
collections on his accounts he will be embarrassed. He does it by borrowing 
the necessary amount to tide him over. When the funds come in from his 
sales he pays off the loan. The great variety of self-liquidating obligations 
not exceeding six months’ duration are spoken as obligations based on com¬ 
mercial credit. 

Intermediate Credit. —If the advance exceeds six months in duration and 
is to be extinguished within a period of ten years, it is spoken of as inter¬ 
mediate credit. As we shall see when we come to examine the credit institu¬ 
tions, the peculiarity of this field of credit in agriculture has called forth 
a fully developed system of banks adapted to the needs of agriculture. Noth¬ 
ing of a similar nature has been done by the government for any other 
productive group. Possibly there is no occasion for it, but there is a tre¬ 
mendous amount of business of that nature in other fields. 

Investment Credit. —The field of investment is so large that it defies 
even a partial analysis in a brief space. We can see, however, some of the 
oustanding characteristics. (1) Its duration is from ten years to perpetuity. 
(2) The lender looks primarily for the income instead of the recovery of 
the principal. It is true that long-term credit frequently carries a due date. 
But when due the holder thinks of reinvesting instead of spending the prin¬ 
cipal. A similar attitude may be taken by those who supply the funds in 
the other forms of credit but it is not oustandingly so. A closer view of in¬ 
vestment credit will be taken under the analysis of credit institutions. 

Speculative Credit. —We have characterized speculative credit as the 
parasite of other forms of credit. Since little further reference will be made 


234 


THE EXPANSION OF ECONOMIC CONCEPTS 


to this, we shall give a more extended exposition of this form of credit 
at this point in our study. 

The one essential of speculative credit is the employment of credit for 
the purpose of avoiding the spot cash transaction with the hope that a 
future cash transaction may be executed more favorably. It is possibly more 
fully developed in connection with loans on the stock and commodity ex¬ 
changes than anywhere else. But it is by no means limited to these trans¬ 
actions. It is just as certainly resorted to in connection with what on the 
face might appear as strictly a commercial loan. When a borrower on wheat 
or cotton, say, in the warehouse, employs the credit thus realized to enable 
him to hold the wheat or cotton for a rise in price, he is just as certainly 
employing his credit for speculative purposes as is one who borrows for the 
purpose of holding a stock exchange security for a rise in price. It takes 
very little business experience to discover that the same phenomenon appears 
in connection with each of the classes of credit here considered. 

When the speculation is carried on through the exchanges the speculator 
most frequently does not own the security in which he deals. He deals in 
contracts for delivery at a future time. His dealings are handled through 
brokers, and the speculator’s interest is usually represented by a certain 
amount of cash which he leaves with his broker as a margin. In many in¬ 
stances a ten per cent margin is enough. Thus $1,000 in cash will enable 
the speculator to secure a contract for ten thousand dollars’ worth of se¬ 
curities. Because of this fact of a relatively small investment with which 
to control so large an amount of security values, a very small increase in 
the quoted value of the security will net a handsome return on the invest¬ 
ment. Thus a one per cent rise will net a ten per cent profit during the 
interval of time represented by the rise. In the course of a year one might 
easily realize several hundred per cent on the original investment. Thus 
through lucky purchases one might in a comparatively short time become 
fabulously rich. Needless to say, parasitical gains are always made at the 
expense of some one else’s wealth. Whereas some fortunes are made, in the 
long run equally as many are lost. 

With the exception that one cannot borrow on so narrow a margin, the 
nature of speculative transactions outside of the exchanges is not materially 
different from that of those handled through the exchanges. But the problem 
of regulation of speculation outside of the exchanges is a simpler one. If the 
credit instruments—commercial paper—are so adjusted to the loan that they 
will encourage strictly productive transactions and not encourage holding 
for a rise in price, speculation outside of the exchanges will be materially 
reduced. Considerable work has already been done in this regard since the 
establishment of the reserve banks. 


CREDIT 


235 


The fact that we have characterized speculative credit as strictly par¬ 
asitical may cause dissent. Yet when we remember that the productive aspects 
of dealings in futures is not genuinely speculative—that is, it does not rest 
on the chance of profit by a rise or fall in price—we can see that purely 
speculative credit is parasitical. The dealer who quotes the offering price to 
one who desires to sell to cover a hedge expects the price to rise just far 
enough above his quotation to compensate him for his expert knowledge of 
the market. He is not gaining at the expense of anyone else but instead is 
performing a very important service of enabling spinners, millers, and others 
to protect themselves from the impact of price changes. These futures 
transactions are no more parasitical than are those of other forms of 
insurance. 


Credit Institutions. —Credit institutions are simply banks. A bank is 
best defined as an institution that facilitates exchanges by means of credit. 
Since there are a number of different types of credit there must likewise 
be almost as many different types of banks. Were it not for the existence 
of credit institutions it would be much more difficult to complete the 
multiplicity of credit circles than is possible through the agency of these 
institutions. 

Classification of Credit Institutions .—In spite of the fact that banks 
correlate with the different forms of credit, any classification of banks has 
to take into consideration so many other matters that it is not practicable to 
group them solely in accordance with the types of credit that each serves. 
We have found the following bases of classification most helpful: 


1. Legal status. 

(1) Public—owned and operated by the state. 

(2) Quasi public—privately owned but state directed. 

(3) Private—owned and directed by private individuals. 

a. Unincorporated. 

(a) Single proprietorship 

(b) Partnership 

(c) Joint stock 

(d) Trusteeship 

b. Incorporated 

(a) Charters granted by States 

(c) Charters granted by Congress 

(d) Charters granted by other nations 

2. Economic functions 

(1) Commercial 

(2) Intermediate 

(3) Investment 

3. Method of operation 

(1) Deposit and discount 

(2) Savings 

(3) Trust companies 

(4) Credit brokers 


236 


THE EXPANSION OF ECONOMIC CONCEPTS 


4. Customer control 

(1) Capitalistic—profit making 

(2) Cooperative—stockholders and borrowers the same persons 

(3) Mixed—partly cooperative and partly profit making 

J. Territorial activity 

(1) Domestce 

(2) Foreign 

(3) International 

There are, of course, many other bases of classification. We could, for 
instance make a classification according to the types of architecture of their 
buildings, or according to clientele, etc. We believe that the different bases 
of classification here given are the ones which will be most helpful in 
identifying the different ways of alluding to banks. An interesting exercise is 
to select at random any bank you please and show where it falls in each 
of the classes. 

For our purposes the classification according to economic functions 
will receive major consideration, while the other bases of classification will 
be alluded to only incidentally. 

Institutions, of Commercial Credit .—The word bank is more frequently 
associated with commercial banking institutions than with any other institu¬ 
tions of credit. This happens probably because of the fact that it is with 
them that we deposit our money and on them that we draw our checks. They 
are also more numerous than any of the others. In them are deposited most 
of the funds of any civilized nation. 

The commercial bank is a very simply organized institution. It is best 
understood, however, by being approached from four points of view, namely, 
(1) its relation to the depositors (2) its relation to the borrowers (3) its 
relations to other institutions of its kind, and (4) its relation to the state. 

(1) Relation to the Depositors .—The early practice was to charge de¬ 
positors for the service of taking care of their money. That was certainly 
true of the Bank of Amsterdam (1609-1819). That bank came into being 
because of the great variety of coins that drifted into Amsterdam from 
different parts of the world. Holland engaged in commerce with many 
nations. As a result coins flowed into Amsterdam bearing the stamps of 
many different nations other than Holland. Many of the coins had been 
clipped and it was difficult for the possessors to know their value. The Bank 
of Amsterdam was organized for the purpose of enabling the merchants to 
ascertain the value of those coins. Besides the money could be left with the 
bank for safe keeping. The bank gave its receipt for the money left with it. 
Naturally these receipts soon began to circulate and perform the work of 
money. In fact it became more convenient to use the "certificates of deposits” 
than the money. The bank, therefore, instituted a charge of one per cent 
for each six months’ use of its paper. The depositor was required to appear 


CREDIT 


237 


at the end of each six-month interval and settle with the bank or forfeit his 
deposit. A surprising thing to us today is the fact that the bank failed 
because of the fact that depositors learned that the bank was engaging in 
the practice of lending to traders some of the depositors’ money. In other 
words, the Bank of Amsterdam failed because it engaged in a practice 
which is characteristic of commercial banks now. 

Commercial banking as we know it really had its inception with the 
goldsmiths in England. They engaged in the banking business prior to the 
organization of the Bank of England. In fact it is most likely due to the 
experiences growing out of the goldsmith business that the idea of the Bank 
of England came into existence. The evolution seems to have been somewhat 
as follows: In the late middle ages the jewelers and goldsmiths, because of 
the fact that they possessed strong-boxes, became the depositories of other 
persons’ valuables. At first a charge was made for the service, much as is 
still done by banks for safety deposit boxes. With the opening up of trans¬ 
marine commerce there developed in England a class of traders known as the 
adventurers. They were persons who dared to engage in overseas trade at a 
time when that kind of trade was very hazardous. Their needs for funds 
often exceeded their supply of money. With the deposits accumulated in the 
goldsmiths’ strong-boxes the transition from that of being depositories of 
funds to that of middlemen of finance was an easy one, though not rapid. 
By the time of William and Mary the mere goldsmith and safety deposit 
function had sufficiently been outgrown for a number of fairly well de¬ 
veloped commercial banking institutions to have come into existence. The 
practice had developed of bidding for peoples’ deposits. "The paper given 
by these houses to their creditors had acquired a circulation, limited indeed, 
but sufficient to show its convenience.” (Dunbar: The Theory and History 
of Banking, p. 132.) Thus we have another illustration of Mill’s statement 
that practice long precedes science. 

In spite of the fact that, of all types of credit institutions, commercial 
banks have had the greatest development, yet banking institutions, as we 
know them, seem to have come into existence because of the need of public 
credit. It was in England in the year 1694. 

"As an expedient for raising a million sterling, for which no other re¬ 
source could be found, the government in 1694 adopted the scheme proposed 
by William Patterson, a Scotch adventurer, and proposed to Parliament that 
a loan should be offered for public subscription and made attractive by grant 
of incorporation, with banking privileges to be enjoyed by the subscribers and 
their successors. The measure . . . was passed after a severe struggle, and thus 
the Bank of England came into existence as a Whig corporation. 

"The act of 1694 provided for a loan to the government of £1,200,000, 
bearing interest at eight per cent, and incorporated the subscribers, with this 


238 


THE EXPANSION OF ECONOMIC CONCEPTS 


amount of nominal capital, as the Governor and Company of the Bank of 
England ,—the title which has never been changed. The corporation was 
empowered to deal in coin, bullion, and exchange, and to lend upon security, 
but was forbidden to deal in merchandise in any form.” (Ihid. 133.) The 
gradual expansion of the work of the Bank of England, and the growth of 
other joint stock institutions in England, and Great Britain, make an interest¬ 
ing story. But it cannot be told here. 

A closer focus on the relation between commercial banks and the de¬ 
positors, as this relation has come to be today, reveals several outstanding 
features. They are: (1) the banks are eager to receive the depositors’ ac¬ 
counts—so much so that they no longer charge for the service of taking 
care of the deposiors’ funds and paying their bills for them. There is, how¬ 
ever, an exception made today in the case of accounts that fall below a 
certain minimum. When the cost of the account to the bank is greater than 
the profit from the account the bank will usually charge a nominal amount 
as a service charge. In addition, the practice of renting safety deposit boxes 
is a definite survival of the former practice of having the goldsmiths care 
for one’s valuables. (2) The bank in effect says to the depositor, "Leave 
your money with us and we will pay your bills for you.” It is very much 
to the advantage of the depositor to do so. In spite of the fact that banks 
do fail, the probability of loss from bank failures is much less than that 
it would be if the money is kept anywhere else. Then, too, it is much more 
convenient to pay one’s bills by means of checks than by any other method. 
The check automatically makes change. It adapts itself as well to a large 
payment as a small one. (3) The bank’s ability to do a profitable business 
is dependent on its ability to retain the confidence of its depositors. It needs 
to be remembered that the only reason why a bank makes a bid for deposits 
is the fact that it can lend the money left with it at a profit. A comparatively 
small ratio of deposits is maintained. If the deposits were kept in the bank’s 
vaults, banking today would not be different from that of the Bank of 
Amsterdam or that of the goldsmiths. The banks would have to charge for 
their services to the deposits. Thus we see that it is because of the fact that 
on the average not over twenty-five or thirty per cent of the deposits are 
demanded in cash at any one time that the bank can safely lend out the 
balance. In fact, the bank’s loans will usually be three or four times as much 
as the cash left with it by the depositors. From this it appears evident that 
if all the depositors demanded their deposits at once the bank would have 
to close its doors. The bank’s ability to do a profitable business is dependent 
on its ability to retain the confidence of its depositors so that only a small 
percentage of the deposits will be demanded at any one time. 

(2) The Relation to the Borrower. —On the books of the commercial 
banks, any particular deposit is as likely to represent a loan as it is actual 


CREDIT 


239 


cash left with the bank. This happens because when a bank makes a loan 
the loan is usually granted by simply making a deposit entry to the credit 
of the borrower. Of course, on the assets side of the balance sheet the deposit 
thus made has to be matched by a note given by the borrower. The assump¬ 
tion is that the borrower will desire to write checks against the account 
much as he would do if he had actually left cash funds with the bank. To 
the extent that the borrowers as a whole employ their loans merely for the 
purpose of checking against them, money payments are rendered unnecessary, 
for exchange transactions are then completed entirely on credit. To the extent 
that depositors actually leave their funds with the bank the bank’s need for 
cash is dispensed with. It is conceivable that all money payments might be 
dispensed with through the media of bank checks, and other forms of bank 
drafts. At any rate it is due to the proclivity which the banks’ customers 
have of matching their obligations against one another and thus dispensing 
with the need of actual money payments that the banks can safely allow 
their loans to exceed their actual cash several times over. 

The bank, therefore, makes money by lending its credit really more 
rapidly than by lending other people’s money. The possession of other people’s 
money makes it possible, however, for the bank to lend its credit. If cash 
deposits were left with the bank to the extent of say, $500,000 the bank 
could safely lend out as much as $1,500,000 —three times the actual cash. 

Then, too, even if the depositors should in fact demand cash, the bank 
has a way of supplying their needs without actually handing over the cash. 
That is done by handing out bank notes. Not all banks have, under the law, 
the note-issuing power, but banks which have that power can lend their 
credit as readily by means of notes as by means of deposits. For most purposes 
bank notes will function quite as well as cash. Particularly is that true when, 
under the authority of the government, the notes are made to look like 
government paper money. Through the instrumentality of deposits, which 
enter exchange transactions by means of checks and bank notes, it becomes 
well nigh possible to dispense with most other media of exchange. In fact, 
bank notes, in most civilized nations, have become an essential part of the 
fiduciary money. 

The vital point in the relation between the bank and the borrower is the 
contract between the borrower and the bank. Here we find the great body 
of negotiable paper. Presumably, when a bank makes a loan, it has taken 
ample precaution that the loan will be returned when the loan falls due. In 
commercial banks the security left is supposed to be some form of "com¬ 
mercial paper.” The term commercial paper itself has had many different 
uses. Fundamentally it means simply negotiable paper given in exchange for 
a loan the nature of which is self-liquidating within a period of not more 
than six months. It may be merely an unsecured promissory note; or it may 


240 


THE EXPANSION OF ECONOMIC CONCEPTS 


be unsecured two-name paper such as the trade acceptance; under some cir¬ 
cumstances it may even be bank acceptances; it may be notes secured by 
bills of lading covering goods in transit, or notes secured by warehouse re¬ 
ceipts, or even notes secured by chattel mortgages. The essential point is the 
use to be made with the purchasing power obtained by the loan. To be 
commercial credit it must be self-liquidating within a period of not more 
than six months. It is primarily a source of working capital for industrial 
and mercantile establishments. 

Only a small per cent of the loans of commercial banks can safely be 
placed to any other purpose. This is true because the funds have to be kept 
revolving. Just why this has to be done is not evident on the face. Clearly 
there is no need at any time to have all of the cash on hand. The real reason 
is that commercial banks cannot afford to accommodate any one customer 
at the expense of another. The total volume of credit varies but little from 
time to time. But those who need the loans need them only part of the time. 
The duty of the bank is so to adjust the demand for and supply of credit 
for commercial purposes that the loans will not become top-heavy at any 
point. It is therefore highly important that many of the notes be paid when 
they fall due, and that a large percentage of them fall due each day. 

The bank’s portfolio is composed of the credit instruments left with the 
bank as evidence of loans granted. The character of the paper in the portfolio 
determines the character of the bank. Banks, other than commercial banks, 
hold other sorts of paper than commercial paper. 

The mere fact that the loan committee has been careful to keep the loans 
to those with commercial purposes does not guarantee the soundness of the 
bank. The authorities of the bank have to filter out those loans that will 
be paid when they come due, or the bank will encounter difficulties. 

The working out of standards for building up and maintaining financially 
sound bank portfolios belongs to the study of bank administrative procedure. 
Many points connected with the subject are technical in nature and belong 
to a more specialized study than this. 

(3) The Relation of Banks to One Another .—No one commercial bank 
can secure all the business of the nature adapted to that type of credit in¬ 
stitutions. Banks, nevertheless, have to maintain a very close relationship 
with one another. The peculiar nature of their business makes it imperative. 
Except for the physical impracticability of handling the business, one bank 
could better handle the commercial banking business of a nation than it 
can be handled by many institutions working separately. The reasons why 
one big bank could theoretically perform the commercial banking services 
better than a multiplicity of separately owned banks are mainly two. They 


CREDIT 


241 


are (1) a more economical utilization of money, and (2) a better adjustment 
of credit to business needs. 

Professor Gide has expressed the first point in the following language: 

"Suppose that there are three countries, or three persons, whom we will 
call A, B, and C. Suppose A is a debtor to B, and that B is a debtor for the 
same amount to C, who in his turn is a debtor to A. Is it not evident, then, 
that instead of passing the sum of money owned by these three debtors to 
their three creditors round the whole circle—making A pay £1,000 to B, 
who then pays £ 1,000 to C, who finally hands back the money to A, from 
whom it came in the first place—it is simpler to settle the whole business 
without paying a farthing? # 

"But of course it will be said that it is highly improbable that C will be 
debtor to A in this convenient fashion, so as to close the circle, as it were. 
This is true; but if C is not a debtor to A, he will perhaps be a debtor to 
D, or E. or F, or G, or H, so that the credit instrument chances ultimately 
to reach some one who is A’s debtor, and then the problem is solved. The 
more persons there are taking part in the game, the larger the circle will be, 
and obviously the more chance there will he of closing the circle , of buckling 
the strap, so to speak. Besides, there are intermediate agents whose express 
business is to turn these chances into realities. These are the bankers, in 
whose hands the cheques and bills of exchange of A, B, C, etc., will eventually 
collect.” ( Principles of Political Economy, pp. 285-6.) 

With regard to the second point we shall quote at some length from 
a second authority: 

"But the supposition of a sole or isolated bank is far removed from 
business facts. In the United States there are thousands of banks; many 
communities have more than one between which customers divide their 
patronage. A customer of bank A may hand a check to a customer of bank 
B, who will deposit it with B, and B will collect the cash from A. The 
loss of the cash by A in meeting such collections over the counter, through 
the mails, and at the clearing house, would seriously affect the ratio of cash 
to deposits and endanger the ability of the bank to meet its demand liabilities. 
Now if one bank, by the method of loans and discounts, creates an unduly 
large sum of deposits, it is sure to suffer adverse clearing house balances, 
for, although many of the checks drawn against these accounts will be re¬ 
deposited in the drawee bank by holders into whose hands they fall, many 
others will be deposited in other banks which will collect cash from that 
bank. Of course, if all other banks of the system are creating deposits at the 
same place, it is possible that checks drawn against A and deposited in banks 
B, C, D, and E, will just equal those drawn against B, C, or D, respectively, 
and deposited in A. But if any one bank creates deposits out of proportion 
to the others, it faces the impossibility of maintaining its cash. For the bank- 


242 


THE EXPANSION OF ECONOMIC CONCEPTS 


ing system as a whole the deposits may reach a high multiple of the cash 
reserve, but the multiple for any one bank of the system subjects it to 
danger of being forced to suspend cash payments.” (Westerfield: Banking 
Principles and Practice , pp. 66-67.) 

The following formula, given by Professor Westerfield, is helpful in 
understanding the extent to which the lending power of the bank might be 
expanded under certain contingencies: 

Let L equal lending power 
Let c equal cash 
Let r equal reserve 

Let b equal balance required to be kept in the bank by the borrower 

With these assumptions Professor Westerfield derives the following 
formula: 

c (1 r) 

L =- 

1 — b + br 

The use of the above formula reveals some interesting facts. For instance 
if a bank has cash to the extent of $1,000 and the reserve ratio is 12%%, 
while the required balance is 20% its lending power is $1,060. Now if the 
balance rises to 100% its lending power rises to $7,000. Then again if the 
balance rises to 100% and the reserve sinks to 0 the lending power of 
the bank rises to infinity. 

From this we see if one bank could get all the business, and bring it about 
that everybody would employ bank credit instead of money in trading, then 
the limit of the bank credit would be infinity. Since banks compete with 
one another for the business it becomes necessary for them to find ways of 
cooperating to the end that they may at least not be handicapped with regard 
to their potential expansion of credit. A perfectly coordinated system of 
banks would have a lending power as great as would be the case with one 
bank which was able to secure the same amount of business as that done 
by the banks in the system. 

There are four ways that banks coordinate their affairs. They are (1) 
through clearinghouse associations, (2) through correspondents, (3) through 
bank chains, and (4) through reserve banks. The last of these, unfortunately, 
does not readily come into being spontaneously. For that reason it will receive 
attention under the heading of the relation of commercial banks to the state. 

Clearing House Associations .—In communities of any size there will in¬ 
variably develop a number of separate banks. Since it is impossible for all 
the checks drawn on any particular bank to be presented for payment at 
the bank on which they are drawn it becomes necessary for the banks to 



CREDIT 


243 


work out a plan of matching checks against one another to avoid the neces¬ 
sity of passing funds back and forth. 

"A good many conditions must be fulfilled, therefore, if the cheque system 
is to become universal in any country, but one primary and essential condi¬ 
tion is the habit of depositing money in the bank. In this case alone can 
the cheque bring about the economic revolution to which we have referred— 
namely, the elimination of cash payments. This revolution is already on the 
way in England and America. All the bankers in these countries are debtors 
and creditors of each other for enormous sums, and so their London and New 
York agents have nothing to do but to balance their accounts. That is done 
every day when they meet together in the Clearing House. This is an institu¬ 
tion of long standing in England, for it dates from 1773. Transactions are 
settled there, by the simple method of compensation, which amounted before 
the war to nearly sixteen thousand million pounds a year . . . Metallic money, 
and even notes, appear only as an insignificant balance.” (Gide: Principles 
of Political Economy, pp. 297-8.) 

If the reader will solve the following problem it will be of assistance 
in understanding the working of the clearing house associations. 

Suppose that A, and B, and C, and D, and E are banks constituting a 
clearing house association. On a given date they present checks for clearing 
as follows: (Day and Davis: Questions on Economics, prob. 24.10.) 


By 


Against 



A 


15,250 

19,400 

10,325 

10,150 

B 

11,175 


17,900 

7,500 

9.125 

C 

20,750 

18,100 


14,075 

12,175 

D 

9,250 

8,475 

13,325 


7,100 

E 

9,325 

7,650 

9,175 

10,525 



The problem is to find the total amounts due to and by each bank, the 
balance due to or by each bank with respect to the clearing house, and the 
percentage of checks settled by offset. 

The solution of the above problem will immediately reveal that the clear¬ 
ing house occupies the position of an intervening agency for the settlement 
of balances. The amount due the clearing house from those banks that have a 
greater debit than they have credit must exactly equal the amount which the 
clearing house owes those banks which have more credit than debit. As 
soon as it is known that any particular bank owes funds to the clearing 
house, arrangement has to be made to settle the account so that the clearing 
house may have funds with which to discharge its obligations to the banks 
which have funds coming to them. Formerly a number of different ways 
were employed to avoid the exchange of actual cash. Now, however, the 
balances are usually covered by checks drawn on the reserve bank. 












244 


THE EXPANSION OF ECONOMIC CONCEPTS 


Bank Correspondents .—Banks cannot help having out-of-town relations 
any more than they can prevent checks drawn on them from being cashed 
at other banks in the same town. These out-of-town relations may even 
extend into foreign countries. The fact of out-of-town credit relations gives 
rise to the business of domestic and foreign exchange. Fundamentally these 
exchange transactions are no more than amplified clearing house relationships. 
The facts of distance, volume of credit handled, and lack of ready adjust¬ 
ments, and the further fact of the influence of the movement of goods from 
one section to another, make the problem in many ways more puzzling than 
that of the local clearing house association transactions could possibly be; yet 
fundamentally domestic and foreign exchange possess the characteristics of 
clearing houses. 

The way that the system of bank correspondents fits into the great 
credit structure is not difficult to comprehend. It grows out of the fact that 
a bank for certain purposes needs to carry deposits in other banks. The rela¬ 
tion, therefore, between a bank and its correspondent is similar in many 
respects to the relation between the individual depositor and the bank. A 
bank needs correspondents for at least three purposes. They are: (1) the 
establishment of checking accounts in other cities; (2) the borrowing of 
funds in time of stress; and (3) the outlet for surplus funds in more 
favorable markets. 

Checking accounts in other cities enables the bank to draw cashier’s 
checks so as to accommodate its customers who may need funds in these 
cities. Against these accounts are also charged personal checks drawn on the 
depositing bank which may find their way into the clearing houses of 
other cities. 

Except in time of general financial stress it is possible for a bank’s cor¬ 
respondent to come to its help when it has need for more funds than it 
can command. In times of great stress it is hardly possible for the corre¬ 
spondent to render much assistance. Then all banks are more or less in 
jeopardy. But the occasional service which a correspondent can render to its 
customer banks, by lending to those banks, makes that one of the im¬ 
portant occasions for a bank’s having correspondents. 

There may not be an outlet at home at all times for the available funds 
of any particular bank. By maintaining a system of correspondents banks 
can divert their funds to other credit centers so as to more nearly keep their 
funds working. 

Bank Chains .—Banks frequently find it desirable to create a closer rela¬ 
tionship than merely that of a depositor and correspondent. Where relatively 
small commercial banks have grown up independently of one another and 


CREDIT 


24* 


where they have been handicapped by law which hinders th formation of 
branch banks, we are likely to find the creation of bank chains. 

The chain bank is simply the adoption of the holding company device 
to bank organization. Each separate bank retains its corporate form and 
entity, has its board of directors, president, and other officers and employees. 
But a controlling interest of its stock is held by an outside agency. Where 
the law allows genuine holding companies—corporations created with the 
specific intent of securing a controlling interest in the banks that it desires to 
dominate—chain banks will take the holding company form. When the law 
forbids that one corporation own stock in another the same result is accom¬ 
plished through the familiar device of trusteeship. Sometimes other agencies— 
insurance companies, for instance—control a chain of banks. In other cases 
certain wealthy individuals may, through the ownership of stock in banks, 
control a chain of banks. Always the member banks retain their separate 
entity; but their policies are dominated from above. 

Those independent banks which find themselves in competition with banks 
which connect up with bank chains, experience difficulty in holding their 
own in competition with them. This is due especially to the fact that the 
chain system makes possible certain economies not possible for banks operat¬ 
ing separately and apart. 

Chain banking has practically all of the advantages of branch banking. 
From the standpoint of the depositors and other creditors they are not as 
safe as branch banks. The inferiority is due to the fact that in chain banks 
each bank retains its corporate entity. Thus if any member of the chain has 
to liquidate, the settlement with its creditors is based on the relation of its 
own liabilities to its assets. If the branch of a big central banking system 
for any reason has to cease to operate, the assets of the whole system are made 
available for the extinction of the obligations of the branch. Losses, therefore, 
fall on the banking system as a whole instead of on the individual deoositors 
and other creditors, when the assets of the local bank are not sufficient to 
pay out the creditors. Of course, it is conceivable that a big branch banking 
system may fail. But there is a much less likelihood of it. Economically speak¬ 
ing, therefore, branch banking is superior to chain banking. It is therefore 
somewhat unfortunate that legal restrictions thrown around the creation 
and operation of commercial banks have forced them to form chains instead 
of developing branches. This brings us to the relation between banks and 
the state. 

(4) The Relation of Commercial Banks to the State .—Most commercial 
banks are incorporated. Because of that fact the conditions of their creation 
and operation can be rigidly determined by the state. The unfortunate ex¬ 
periences which practically every civilized nation has encountered with 


246 


THE EXPANSION OF ECONOMIC CONCEPTS 


zealous proponents of banking institutions has resulted in a more rigid system 
of laws covering the banking business than that of almost any other business. 
The result has been a greater variety of systems of laws covering the bank¬ 
ing business than that of any other. The result has further been a variety 
of systems of bank administration all of which are directed more or less 
toward the same ends. The ends sought are: (1) prevention of the formation 
of too many banks, (2) legal reserves, (3) special bank supervisions, (4) the 
regulation of the issue of bank notes, and ( 5 ) the assurance of the existence 
of institutions of rediscount. 

Limitation of the Number of Banks .—In the United States fewer pre¬ 
cautions have been taken with regard to the number of banking institu¬ 
tion that come into existence than in most civilized nations. At the same 
time it is doubtful that the public is as well served by commercial banks in 
the United States as in some other countries. The difficulties encountered in 
the operation of a dual system of government is probably responsible for the 
situation as it has developed. The story is a long one and cannot be told here. 
(See White, Money and Banking , Book III.) 

The result of our hectic experience with banking has been the rather 
niggardly granting of bank charters by the established authorities. Under the 
national government charters for national banks are granted by the comp¬ 
troller of the currency. Any group of five persons who are citizens and 
reside in the locality where the bank is to be organized, and who can get 
together the required amount of capital (minimum of $25,000) may make 
application for a charter. The application has to be endorsed by three men of 
prominence who do not own stock. But the comptroller is empowered to 
reject any application if in his opinion the banking needs of the community 
in which the bank is proposed to be established are already taken care of. 
A report of one of the bank examiners is required to ascertain the facts as 
to the need for the proposed bank. 

The plan of approval of charters by State authorities is not materially 
different from that of the national government. In all States some authority, 
such as the head of the Department of Banking, is authorized to approve 
or disapprove of the applications for bank charters. Banks are allowed to be 
organized with a smaller capitalization than that of national banks. Every¬ 
where the authority granting the charters is authorized to reject applications 
if it is found that banking services are already well cared for. In spite of the 
caution that has been exercised by the authorities granting bank charters, 
the tendency in this country has been to overdo the banking business, so far 
as it relates to the banking overhead. At the same time there are many com¬ 
munities that do not secure efficient banking services. 

Other nations have followed a different plan of limiting the number of 


CREDIT 


247 


banks that come into being with somewhat better results. In Canada, for 
instance, a capitalization of $500,000 is required. The result is that there are 
only about a dozen banks. Each bank, however, has numerous branches. Thus 
it is possible, through the instrumentality of branches of one or more of the 
large central institutions, to supply banking services wherever they are needed 
without serious danger of too much duplication of plants. Then, too, the 
closing of a branch does not jeopardize the funds of the depositors. The cen¬ 
tral institution is responsible for the obligations of its branches. More com¬ 
plicated systems exist in England, Germany and France. But in those coun¬ 
tries the general policy is that of large central institutions which extend their 
activities through branches. 

Legal Reserve Requirements .—Legal bank reserves assume two forms. 
They are: (1) special assets reserves, and (2) cash reserves. 

Special assets reserves are easily accounted for. The reason for them grows 
out of the fact of the peculiar importance of banks as business entities. 
Bank credit needs special precautions to assure its safety. The failure of a 
bank is much more serious than the failure of any other type of corpora¬ 
tion. Because of that fact it has become the practice for the law to place 
exactions on banks not usually required of other corporations. These relate to 
stock surpluses and stockholder liability. With regard to the first of these, 
banks are forbidden to declare dividends before they have accumulated a 
surplus equal to at least 20% of the par value of its stock. In fact that 
surplus is usually created at the time of the creation of the corporation by 
selling the stock above par. But, be that as it may, the surplus exaction is 
one not usually required of other private corporations. 

The stockholder liability exists in the well-known liability feature. This 
means that in case of the failure of a bank each stockholder is liable for an 
assessment equal to the par value of his holdings. To make this requirement 
stick, a further precaution is also taken making the liability extend even 
though the stock has been transferred. 

The cash-reserve requirements are somewhat more complicated. 

The most usual explanation of the cash-reserve requirement is that it 
is required so that funds will be available to enable the bank to meet an 
emergency demand for money. Only to a very limited extent is that possible. 
If the money kept in the reserve were available to meet current obligations it 
would no longer be possible to count them as part of the reserves. If, however, 
a reserve is required to meet a definite obligation, as is the case with the 5 % 
redemption fund required for bank notes, and if in times of stress other 
reserves are allowed to be reduced, as is the case with the reserve requirements 
of the Federal Reserve Banks, the reserve does have some possibility of being 
used. But certainly fixed reserve ratios can have no such purpose. 


248 


THE EXPANSION OF ECONOMIC CONCEPTS 


There is, however, a very real function of the cash reserve ratio to de¬ 
posits and notes outstanding. If we remember that the lending power of a 
perfectly coordinated system of banks is practically unlimited, if no reserves 
are required, the function of the legal reserve becomes evident. As long as the 
law requires that a definite reserve ratio be maintained we have a very 
substantial check on inflation of prices through the medium of bank credit. 

The enumeration of the various cash reserve requirements of different 
banking systems of the world is far beyond the province of this particular 
study. We shall confine our attention to those in the United States. 

Prior to the passage of the Federal Reserve Banking Act the reserve 
requirements for the national banks were as follows: The banks were divided 
into three classes, namely, those in central reserve cities, those in reserve 
cities, and those in other places. The class into which any particular city 
would fall was determined largely by the amount of business the banks 
located in that city could get from banks located in other cities. Central 
reserve cities had to have a minimum population of 200,000, whereas reserve 
cities, since 1903, could have no less than 25,000. Banks located in the cen¬ 
tral reserve cities were required to carry 25% cash reserves against their 
deposits; in reserve cities the requirement was also a 25% reserve, but half 
of that amount could be shown to be on deposit in banks located in central 
reserve cities. A 15 % requirement was exacted of banks located elsewhere, 
but three-fifths of that amount might be shown to be on deposit in banks 
in the larger cities. A careful periodic check was made through a system of 
bank examiners to see that those reserves were maintained at all times. 

The cash reserve requirements of the national banks had several unfortu¬ 
nate results. In the first place they were inflexible. In spite of the fact that 
the fundamental purpose of the cash reserve is not that of actual utilization, 
but instead the prevention of inflation of credit, yet the reserve can better 
perform its function if the law allows a suspension, under penalty, of course, 
of the limit in times of great emergency. That change has been made in the 
law covering the reserve requirements of the Reserve Banks. 

In the second place the system of redeposit in other banks doing the same 
kind of business had unfortunate consequences. The fact was that most of 
the redeposited reserves were carried in the New York banks. This practice 
gave Wall Street a strategic position in our financial structure that proved at 
times to be disastrous. The principal reason for carrying the deposits in the 
New York banks was to take advantage of the opportunity to lend at call in 
connection with stock market transactions. Now, loans for speculative pur¬ 
poses are not commercial loans. If based on corporate securities as collateral, 
loans at a commercial bank place the bank in greater jeopardy than specula¬ 
tive loans placed on commodity paper. The result was that flurries in stock 
market transactions produced "tight money.” The inability of the Wall 


CREDIT 


249 


Street banks to meet their obligations reacted on the whole commercial- 
credit structure and frequently precipitated financial panics. Persons with 
bank balances were unable to secure their funds, and those needing loans 
were unable to procure them. The result was that in times of business depres¬ 
sion there usually came a plethora of bank failures. 

It should be noted, however, that it was not so much the fact of keeping 
the redeposited reserves with the New York banks that caused the trouble, 
it was the fact of pivoting all available surplus funds of the different banks 
in the country, at times, in the New York banks. In other words, the trouble 
grew out of the tendency to divert too great proportion of the loanable funds 
to purposes not commercial in nature. The legal authority to redeposit cer¬ 
tain portions of the required cash reserves certainly was influential in bring¬ 
ing about the top-heavy institutional credit structure that existed prior to 
the passage of the Reserve Act. The real cause, however, lay deeper. 

With the passage of the Federal Reserve Act, the situation just described 
was materially changed. In the first place the reserve requirements them- 
slves were altered. Now a distinction is made between the ratio to demand 
deposits and to time deposits. The ratio as a whole has been materially low¬ 
ered. The classification of banks, however, is retained. Those located in cen¬ 
tral reserve cities are now required to maintain a reserve of 13% against 
demand deposits, those located in reserve cities 10%, and those in other 
cities 7%. In each instance an additional 3% reserve has to be kept for time 
deposits. The reserves, however, are all required to be kept in the Reserve 
Banks. In the second place it is no longer as attractive to lend on speculative 
paper as it was. This is true because of the fact that only instruments grow¬ 
ing out of commercial-credit transactions are available for rediscount at the 
Reserve Banks. It is still possible for banks to keep a portion of their loanable 
funds in New York. But the fear that they may need to rediscount some 
of their paper serves as a deterrent to that procedure. It tends to prevent the 
commercial-credit institutions from allowing an inordinate percentage of 
their funds to flow into non-commercial channels. 

In addition, the twelve Reserve Banks are now required by law to keep 
reserves of their own against their notes and deposit liabilities. The Reserve 
Banks in each district now occupy such a dominant position among the 
credit institutions as almost if not quite to overshadow the influence of Wall 
Street. The authority and the influence of the Reserve Board operating 
through the twelve Reserve Banks and their branches have elevated the 
standards of commercial-credit institutions so much as almost to eliminate 
financial panics. 

Special Bank Supervision .—Where high standards are not maintained for 
the creation of commercial banks, as is the case in the United States, it has 


250 


THE EXPANSION OF ECONOMIC CONCEPTS 


become necessary for the government to assume a paternalistic attitude 
toward the operation of the banks. We have already noted that a system of 
bank inspection is maintained for the purpose of assuring that national banks 
hold at all times the required cash reserve ratios. Likewise State banks have 
their reserve requirements under the State laws, and each State also 
operates a system of bank inspectors. These inspectors walk into the banks 
unannounced and demand the right to examine the records for the purpose 
of ascertaining whether or not the banks are violating the law. The cash 
reserve ratio is only one of a number of things that the inspectors look for. 
Many other requirements exist. For instance, not more than ten per cent of 
a national bank’s capital and surplus may be loaned directly to any one appli¬ 
cant. Only a certain per cent of the loans may be placed on real estate. In 
fact there are rather meticulous restrictions in Section 5,200 of the Revised 
Statutes and the bank inspectors are supposed to see to it that none of them 
are violated. 

The system of bank inspectors is an annoying one to banks. It has 
developed in this country, however, as a result of our hectic experience with 
banking during the 19th century. Other nations, which maintain a higher 
standard for the creation of banks, find it less important to maintain such a 
rigid system of bank inspection. 

Bank supervision extends as well to the requirement of periodic reports 
as it does to the inspection of banks. Both state and national banks have to 
make reports at call of the established authorities. For the information of 
the public the reports made to the government are required to be published 
in the local papers. 

The Regulation of the Issue of Bank Notes .—No aspect of the credit 
phenomena has given a greater concern to students of economic theory than 
has bank notes. Theories of their place in exchange transactions have varied 
all the way from the contention that bank notes should presume to do no 
more than merely circulate instead of the metallic money, to save the wear 
and tear of the precious metals, to that bank notes might make possible 
loans without interest or discount. Each of these extremes assumes that the 
state must take a hand in forcing the notes to accomplish the desired ends. 
There is an intermediate contention that bank notes require no regulation 
by the state different from that of any other form of bank credit. The 
assumption in this last instance is that banks should be left free to expand 
and contract the note issues in response to the demand for that form of 
credit, much as is now done with checking accounts. From it all, however, 
has come the conclusion that bank notes do need regulation by the govern¬ 
ment peculiar to themselves. 

The reasons for these peculiar regulations are mainly two. They are: 


CREDIT 


251 


(1) bank credit is superior to individual credit, and (2) bank notes can be 
made to substitute for other money. 

The superiority of bank credit over individual, or business credit, 
becomes evident in the more ready acceptance of bank notes by the common 
run of people than the acceptance of checks. Even if bank notes were not 
engraved to resemble government paper money they would still find a much 
wider circulation than checks could possibly do. The fact therefore that they 
tend to float out into the channels of trade and are held widely as money, 
even when not given by law the quality of money, makes it essential that 
the government take action to see that the holders do not lose the value of 
the notes in cases of bank failure. 

During the era of state-bank note issues (1836-66) great hardship resulted 
because bank notes were allowed to circulate without precautions having 
been taken to see that the notes of the banks which failed would be redeemed 
in cash. 

With regard to the second point, it is sometimes stated that bank notes 
supply the needed elasticity to our currency. The fact that bank credit will 
expand and contract as readily through checking accounts makes one ques¬ 
tion the accuracy of the statement that bank notes supply any elasticity to 
credit that cannot be supplied without them. When bank notes, however, 
are made to resemble government paper money, the government can provide 
that they be employed to relieve money stringencies. This brings us to an 
analysis of the plan of government regulation of bank notes. 

The evolution of the plan of regulation in the United States shows three 
stages in the development of a satisfactory plan of regulation. (We are 
omitting the experiences with the first and second national banks.) The first 
period (1836-1865) was that of unregulated issues of State bank notes. 
This came as the result of the failure to recharter the second bank of the 
United States—the consequence of Jackson’s war on the bank. During that 
period there were only a few banks that operated according to sound business 
principles. There was no uniformity of note issues. Literally thousands of 
varieties of bank notes were forced into circulation by unscrupulous "wild 
cat” bank promoters. The results were disastrous. 

The second period (1866-1913) was that of rigidly regulated bank note 
issues. With the passage of the National Banking Act and the outlawing of 
state bank notes with a tax of 10% on state bank notes, national bank notes 
acquired a reputable position in our currency. The fact is that national bank 
notes were, and still are as good as gold, so far as they relate to the value in 
the hands of the individuals who possess them. This came as the result of 
the fact that the government saw to it that bank notes would not be 
issued except under conditions which assured their redemption in good 
money in the event of the failure of a bank with notes outstanding. 


252 


THE EXPANSION OF ECONOMIC CONCEPTS 


The precautions taken were: (1) Only banks chartered by the national 
government possessed the note-issuing privilege. That put the banks with 
notes under the direct supervision of the national government. (2) United 
States government bonds had to be deposited with the Secretary of the 
Treasury at least equal in value to the extent of the notes issued by any 
bank. This meant, of course, that the purchasing power invested in the 
bonds was loaned to the government, while the right to issue notes was 
supposed to give the bank lending power which it might employ in place of 
that turned over to the government. At first, notes could be issued only to 
the extent of 90% of the value of the bonds purchased, but in 1900 the 
amount was increased to 100%. But even at that the note issuing power 
did not equal the purchasing power turned over to the government since a 
5 % redemption fund had to be maintained with the Secretary of the Treas¬ 
ury, in addition to the bonds, as a sort of extra assurance that the notes of a 
liquidated bank would be paid. (3) Bank notes were engraved by the gov¬ 
ernment with plates and paper similar to those used for government paper 
money. Thus counterfeiting was made difficult and scarcely anyone was 
aware of the distinction between bank notes and other forms of paper money. 
(3) The notes were given such prior claim on the bank’s assets that there 
was little if any likelihood that the notes would not be paid off in full. In 
addition to the government bonds, and the 5 % redemption fund, the notes 
stood as a first claim on any other assets of the bank. Behind these assurances 
was the government guaranty of redemption. National bank notes, there¬ 
fore, were and are still perfectly good money from the standpoint of the 
individual. They failed, however, to perform satisfactorily the social func¬ 
tion of money that was needed- to be performed by bank notes. It was 
because of the latter fact that the Federal Reserve Banks were established. 

The aspects of the national bank notes that prevented them from per¬ 
forming satisfactorily the needed social functions were: (1) An instrumen¬ 
tality of commercial bank credit was based on an investment security. 
(2) The expansion and contraction of the volume of notes had very little, 
if any, definite relation to the actual monetary needs of the nation. 

The government bond, although possibly the cream of all investments, is 
no more liquid because of that fact than any other long-term credit instru¬ 
ment. The purchasing power locked up in a government bond is there to 
stay until such time as the government can set free enough of its regular 
income to retire it. To the extent, therefore, that the bonds circulate at 
par in exchange transactions, whether the circulation takes the form of 
bonds or bank notes based on the bonds, just to that extent the total pur¬ 
chasing power of the nation has been increased. It is impossible for the bonds 
to circulate as money directly for the very simple reason that they are not 
money. Their ability to be continuously accepted at par is dependent on the 


CREDIT 


253 


availability of cash funds seeking investment at the rate of interest provided 
in the bond issue. Because of that fact, patriotic citizens, who have some¬ 
times advertised that they would accept government bonds at par as cash, 
have soon found that a continuation of that practice would mean ruina¬ 
tion. When, however, the value of the bonds appears in the form of bank 
notes and once find their way into the channels of trade, the readiness with 
which they are accepted and the tendency not to return to the banks for 
redemption means nothing more nor less than an increase of the money 
supply. Furthermore, when once the money supply has thus been increased it 
becomes impracticable for the government to pay off that part of its debt 
which is evidenced by bond issues which have become the basis of note 
issues. A sudden reduction in the volume of money in circulation is just as 
certainly to be avoided—possibly more so than a sudden increase. As a result 
the United States government found itself in the predicament of having to 
keep itself in debt to avoid the unfortunate consequences of a sudden reduc¬ 
tion of the amount of money in circulation. 

It should be noted, however, that it was not the mere fact of the expan¬ 
sion and contraction of the currency brought about by basing the bank 
notes on government bonds that was chiefly objectionable. It was instead 
the fact that the expansion and contraction had little if any direct relation 
to the increase and decrease in the monetary needs of the nation. Because of 
that fact, with the passage of the Reserve Banking Act we have introduced 
another form of paper money—the reserve note (not the reserve bank note) 
—which is issued in such a way as to expand and contract with the varia¬ 
tions in the monetary needs of the nation. 

The reserve notes have guaranties of safety very similar to those of the 
bank notes. They are, therefore, just as good money to the individual as are 
the bank notes, and at the same time measure up to the needed social func¬ 
tions of bank notes. 

The device that gives the reserve notes their superiority is the fact that 
they are based on commercial paper instead of government bonds. Commer¬ 
cial paper almost automatically increases and decreases with the need for 
funds. With well-developed safeguards, therefore, it is entirely possible for 
the Reserve Banks to leave with the comptroller a portion of the commer¬ 
cial paper which they have in their portfolios—received from the member 
banks—and secure in return for it reserve notes. The expansion of the 
supply of circulating media in response to the increase in demand for that 
increase, instead of inflating prices tends to prevent money stringencies. 
When the period of stress passes, the notes almost automatically reduce in 
amount—through the liquidation of the commercial paper used as their 
basis—which reduction tends to hinder an unexpected rise in the prices. 
The tendency to expand and contract automatically has a stabilizing influ- 


254 


THE EXPANSION OF ECONOMIC CONCEPTS 


ence on prices. This is the widely discussed elastic element in our currency. 

The Assurance of Institutions of Re-Discount .—Commercial banking is 
at best somewhat of a hazardous enterprise. The very nature of it is to assume 
to do that which is on its face impossible. The deposit obligations of any suc¬ 
cessful commercial bank must of necessity stand somewhere around three 
times the available cash. Unless that is true the bank will hardly be making 
enough above expenses to continue solvent. In other words, commercial- 
credit institutions at all times guarantee to their depositors to pay at their 
orders three or four times as much money as the banks have on hand. Their 
ability to sustain themselves in the face of such a gauaranty is dependent 
on the law of averages. On the average not more than a third or fourth of 
the deposits will ever be demanded in cash at any one time. Generally, of 
course, the demand for cash is far below that amount. In fact possibly two 
per cent is a more accurate measure of the amount of cash needed most of 
the time in some banks. But unfortunately the law of averages itself some¬ 
times fails to operate. The depositors of any particular bank may become 
panicky, and demand all of their money at once. At times the disaffection 
may become widespread and threaten many different banks at the same time. 
Unless authorities have taken precaution to see that the institutions have 
resources well coordinated great hardship might result without any particu¬ 
lar reason for it. The remedy has been found in having central institutions of 
rediscount. Hence the term reserve banks. In those institutions funds are 
pooled for the purpose of directing them, when necessary, to any center of 
disaffection. 

Unfortunately banks do not readily create those central banks of redis¬ 
count voluntarily. In nations where large branch banking systems have 
developed, the need for governmental intervention in this regard is not so 
great. But where relatively small banking units operate independently of one 
another, as we have in the United States, it becomes imperative that the gov¬ 
ernment require a plan of coordination. This was done through the passage 
of the Federal Reserve Banking Act in 1913. Each Reserve Bank is an insti¬ 
tution of rediscount. 

Briefly the requirements are as follows: All national banks are obligated 
to subscribe for stock in the Reserve Banks to the extent of six per cent of 
their capital and surplus. Thus far, however, only half of the subscription 
has been actually paid by any bank. With the capital thus realized twelve 
Reserve Banks have been created and located at strategic points throughout 
the country. We have already seen that the' required cash reserves of the 
national banks are all kept on deposit with the Reserve Banks. Additional 
deposits may be kept there by the member banks. Practically all of the gov¬ 
ernment’s funds are carried in the Reserve Banks. In fact it has come about 


CREDIT 


255 


that the reserve banks have become the depositories of practically all of the 
monetary gold supply of the nation. In addition, the Reserve Banks them¬ 
selves are so well coordinated under the authority of the Reserve Board that 
the funds of any particular Reserve Bank may be diverted to another if the 
occasion demands. 

Now, let us see how this arrangement is helpful on an occasion of the 
breakdown of the law of averages at any particular time. As the banks were 
operated before the passage of the Federal Reserve Banking Act, whenever a 
disaffection occurred at any particular bank, all other banks began to 
tremble. The failure of one bank reacts on all banks. In rare instances a 
bank’s correspondent might come to its rescue, but more than likely it would 
also be steeling itself for pressure that might assert itself on it. The result 
was that a disaffection anywhere threatened the existence of all commercial 
banks. Under the arrangement now in operation, with the bulk of the funds 
in the Reserve Banks, it is possible to direct enough money at any point of 
disaffection to pay off all depositors. All that is necessary is that the bank 
which needs the assistance be actually financially sound. A number of 
instances have occurred when the Reserve Bank nearest at hand sent money 
by the truckload to succor banks experiencing runs by excitable depositors. 

Of course, the resources of the Reserve Banks are not unlimited. Besides, 
the law requires a gold reserve of 40% against outstanding notes, and 35% 
limits (under penalty) in times of great stress. By resorting to the power 
against deposit liabilities. Yet the Reserve Board has power to suspend these 
to suspend the reserve requirements, and that of issuing reserve notes on 
commercial paper, it is conceivable that now the commercial banking insti¬ 
tutions will be able to meet any emergency. This assumption, however, pre¬ 
sumes that the member banks are themselves following sound commercial 
banking practices. Although the authorities of the Reserve Banks can do 
something in the way of educating local bankers as to what is good com¬ 
mercial banking practice they have no power to demand it. The result is 
that we still suffer from an inordinate number of bank failures. This last 
fact, however, in the opinion of the author is traceable to our plan of 
allowing small, independent commercial banking entities to carry on the 
bulk of the commercial banking business of the nation. 

Other Institutions of Credit. —While it is not correct to say that 
credit institutions have come into being economically adapted to every phase 
of credit, it is true that all of the major classes of credit have institutions 
adapted to their peculiarities. Commercial-credit institutions have received 
extended attention here because of the fact that all other phass of credit 
tend in one way or another to radiate from the commercial banks. Invest¬ 
ments, of whatever kind, at some time or other assume the form of drafts 


256 


THE EXPANSION OF ECONOMIC CONCEPTS 


on commercial banks. Incomes from invested capital likewise appear first 
and last as deposits in commercial banks. The importance of commercial 
banks, therefore, places them in the forefront of credit institutions. Since, 
however, they are not fitted to perform all of the credit needs, other types 
of credit institutions must at least receive some attention. 

(1) Institutions of Intermediate Credit. —Very little governmental stimu¬ 
lation has been necessary to bring into being institutions adapted to the 
industrial phase of credit. In connection with the problem of farm credits, 
however, this has not been the case. As a result we have an expansive sys¬ 
tem of intermediate and long-term credit institutions adapted to the needs 
of agriculture. 

(a) Agricultural Intermediate Credit Banks. —It is possible through the 
Federal Farm Loan system to borrow a small amount—20% to be exact— 
of the value of improvements of farms for use as operating capital. This 
does not go very far in the direction of supplying the needed capital for 
agriculture. The Reserve Banks are also empowered to rediscount agricul¬ 
tural paper on terms somewhat more liberal than strictly commercial paper. 
The established institutions, however, were not sufficient to care for the 
problem of operating capital for agriculture. As a consequence, in 1923, the 
Agricultural Credits Act was passed. It provides for an extensive system 
of credit institutions adapted to that particular form of credit. Loanable 
funds are raised by the sale of bonds based on chattel mortgages placed on 
livestock and other resources employed in the operation of farms. The loans 
made by the intermediate credit banks have a maturity of not less than 
nine months and not more than five years. They are under the immediate 
supervision of the directors of the Farm Loan Banks, and likewise under 
the general supervision of the Federal Farm Loan Board. Loans are secured 
through cooperative associations. 

The act provides for another type of institution known as the National 
Agricultural Credit Corporations. In connection with these, opportunity is 
given for private individuals to form corporations to lend on the same type 
of security as that accepted by the intermediate credit banks. They have 
fewer restrictions thrown around them than the Intermediate Credit Banks 
and are counterparts of the Joint Stock Land Banks. 

We have in these intermediate credit institutions the evidence of the 
careful attention which has been given by the government to problems of 
farmers’ credit. It might seem that little else could be done to put the busi¬ 
ness of farming properly on its feet. These intermediate credit institutions 
superimposed on the great system of land banks, which we shall describe 
shortly, might seem to furnish the final treatment necessary to the agricul¬ 
tural situation. The fact is, however, that much remains to be done before 


CREDIT 


257 


we can satisfactorily bridge the gap between the landless farmers and a 
happy and prosperous agricultural population. So many technical aspects 
of the part played by land in production show up here that it will be 
useless to touch on them until those technical questions can receive separate 
treatment. 

(b) Other Intermediate Credit Institutions. —To assume, as is some¬ 
times done, that the need for intermediate credit is limited to agriculture is 
certainly erroneous. There are, of course, certain aspects of agricultural 
production which calls for special treatment. But the term intermediate 
credit applies to all self-liquidating instruments of credit that extinguish 
themselves between six months and ten years. There is a vast amount of this 
credit outside of agriculture. 

With the exception of general acts of supervision the government has 
paid little attention to the other phases of intermediate credit. We find illus¬ 
trations of them in (1) building and loan associations, and (2) institu¬ 
tions helping to finance installment sales, such as apply to automobiles, fur¬ 
niture, farm implements, etc. A critical examination of such institutions as 
these is beyond the scope of this study. 

(2) Institutions of Investment Credit. —Instead of looking to govern¬ 
ments for sponsorship, many institutions of investment credit are looked to 
by the governments for help in solving their financial difficulties. What is 
it then that differentiates investment credit from other phases? 

Although duration has an important bearing on the distinction between 
intermediate credit and investment credit, yet there is another distinction 
practically always present. Intermediate credit instruments are almost in¬ 
variably self-liquidating. Investment-credit instruments are seldom expected 
to be liquidated. Persons who purchase them do so primarily for the pur¬ 
pose of enjoying the income and leaving the income intact. The result is the 
longer they endure, consistent with safety, the more prized they are. 

It is, to be sure, true that bonds and sometimes stock—anyway, preferred 
stock—do have a due date. When they come due, however, they are most 
frequently paid off with funds secured by another issue of securities. Holders 
of the old issue have the option of investing the money received from the old 
issue in the new one or of placing it elsewhere. In some instances sinking 
funds are established and the investment loans are liquidated. Usually, how¬ 
ever, when that happens the loan has been secured for ten years or less and 
the credit is intermediate credit. Investment loans are resorted to for the pur¬ 
pose of securing capital which is to be conserved and retained. 

From the standpoint of the borrower it takes the form of concrete capi¬ 
tal goods. From the standpoint of the lender it takes the form of lucrative 
capital—the source of an enduring income. Because of these characteristics 


258 


THE EXPANSION OF ECONOMIC CONCEPTS 


investment banks have developed in such a way as best to supply the funds 
for investment purposes. 

(a) Industrial Investment Credit Institutions .—From the standpoint of 
numbers, significant investment banks are counted in the hundreds while 
commercial banks are counted in the thousands. Through a sort of filtration 
process they purify the turgid stream of applications for loans so that those 
seeking a safe place for their savings are protected from loss. Their work is 
mainly that of examining critically proposed security issues—usually put out 
out by corporations—and selecting the issues which meet their standard of 
excellence. An outstanding example is that of J. P. Morgan and Company. 
The reader can find others by turning the advertising pages of any reputable 
financial journal. 

Because of the enviable reputation which investment bankers have won 
for themselves, it has become increasingly difficult for corporations which 
need funds to sell their securities directly. In fact trained investors will 
usually look askance at any security, offered on a wide market, which is sold 
directly by the firm issuing it. The fact is that investment houses can handle 
the issues so cheaply that it very seldom is profitable for corporations to 
market their own securities even when it is possible for them to do so. 

Fraudulent promoters, finding the investment market irresponsive because 
of the prejudice of conservative investors against securities marketed by the 
company of issue, sometimes work a subterfuge and create bogus investment 
houses which go through the form of underwriting low-grade securities and 
offering them indirectly in imitation of investment bankers’ methods. It, 
therefore, becomes necessary for investors to be able to distinguish between 
the genuine and the fraudulent investment house. In this country investment 
bankers have organized themselves into the Investment Bankers Association. 
Membership in the association is not difficult nor expensive. The amateur 
investor, therefore, would do well not to purchase securities from an invest¬ 
ment house unless it is a member of the I. B. A. 

(b) Land Banks .—In agriculture the strategic importance of land 
makes it highly desirable that institutions adapted to supplying loans to the 
farmers for the purpose of enabling them to acquire title to farms be worked 
out. In the industries the value of the site bears such a small ratio to the 
total value of the plant that land values can be pooled with capital values 
without serious consequences. In farming that is not so. Thus we find in all 
progressive nations carefully worked out land banks. Instead of being private 
unincorporated institutions they are corporations created under special acts of 
incorporation. These acts prescribe rigidly the procedure of the institutions 
embraced within the scope of the acts. The work done in the United States 
in this regard ranks high among the civilized nations of the world. 


CREDIT 


259 


The law providing for the establishment of land banks was passed in 
1916. In contrast with the method of raising the capital for the Reserve 
Banks congress in this instance appropriated $750,000 for each of the twelve 
Federal Land Banks. The money thus appropriated was to be returned to the 
government as rapidly as funds could be raised from the sale of stock to the 
borrowers through the Land Banks. In fact the greater part of the money 
has already been returned and the Land Banks have become great coopera¬ 
tive institutions owned by the farmers. 

The unit of the organization closest to the farmers is the Farm loan 
-Association. This is composed of ten or more farmers who desire to borrow 
as much as $1,000 each for the purpose of purchasing a farm. No individual 
loan may exceed $25,000. Associations have been formed throughout the 
nation and there is little reason why any person who may desire a farm 
should not make use of these associations and secure the benefit of the attrac¬ 
tive terms of the loan. 

The amount of the loan, however, cannot exceed 50% of the value of 
the land to be purchased. The appraisal made by the local association is 
subject to review by the Farm Loan Bank. Each borrower has to purchase 
stock in the Farm Loan Bank equal to 5 % of his loan. This means that of 
each $1,000 borrowed only $950 will be available for the purchase of land. 
The money realized from the sale of stock to the borrowers is employed to 
retire the $750,000 advanced by the government. Since the government did 
not charge interest on its advance, all of the earnings of the system, above 
expenses and necessary reserves, are rturned to the borrowers in the form of 
dividends on their stock. These dividends serve to accelerate the liquida¬ 
tion of the loan. The principal of the investment in the stock of the bank in 
the end is credited to the borrower’s account as a final payment on his loan. 

No loan is allowed to be paid out in less than five years. This is done so 
as to make the securities of the farm loan system more attractive as an invest¬ 
ment. Each loan is so amortized as to make each semi-annual payment equal 
in amount. It takes approximately thirty-five years to pay out the loan. The 
payments of principal and interest amount to something less than $70 a year 
for each $1,000 borrowed. 

The money which is loaned to the farmers is secured from the Federal 
Land Bank, or one of its branches, in the district in which the association 
is located. There are twelve of these banks, and each may have branches. 
Each bank is under the control of seven directors. Three of the directors are 
^elected by the local associations; one—a director at large—is appointed by 
the Federal Farm Loan Board; and the other three are chosen by the direc¬ 
tors and are known as the "district” directors. 

The portfolio of the farm loan bank is filled with mortgages which 
flow into the banks from the borrowers. It is the possession of these mort- 


260 


THE EXPANSION OF ECONOMIC CONCEPTS 


gages that makes possible the raising of funds to lend. The greater part of the 
money loaned is raised by selling to the investing public Federal Farm Loan 
Bonds. The principal and interest of these bonds are met by payments made 
by the borrowers. The twelve banks are jointly and severally liable for the 
principal and interest of the bonds. In addition the bonds are issued under 
the supervision of the Federal Farm Loan Board—a group of seven men 
appointed by the President with the consent of the Senate. The farm loan 
bond is a strong instrument of credit and sells with almost if not quite as 
low a rate of interest as a government bond. Since the interest rate on the 
loans is not allowed by law to exceed more than one per cent the interest 
paid on Farm Loan Bonds, the borrowers derive the benefit. Loans, however, 
are not available to anyone except those who own and operate farms. 

Supplementary to the Federal Land Banks are the Joint Stock Land Banks. 
These are privately owned land banks which exist for profit. Dividends go 
to the stockholders much as they do in any other private corporations. They 
do business directly with borrowers without the intervention of local asso¬ 
ciations. It is possible through the joint stock banks for borrowers to 
secure larger amounts of money. The loanable funds are secured by the Joint 
Stock Land Bank Bonds, much as they are secured by the Federal Land 
Banks through the sale of Farm Loan Bonds. They bear a higher rate 
of interest, however, and the higher rate is reflected in the charges to the 
borrowers. 

The Relation of Credit to Value.—T o say that credit institutions 
do not increase wealth of the nation would be as absurd as to say that any 
other typical middlemen were not producers. The fact is that no other inven¬ 
tion has done as much to facilitate production and set men free from their 
environment. It throws producers and consumers into contact with one 
another throughout the limits of the earth. Thus it does more than any 
other single agency to break the grip of scarcity over man’s existence. It 
should always be remembered that goods are valuable because they are 
scarce. The lower value falls, the better off all of us are. Credit, in facilitating 
exchanges and in stimulating production tends to lower values and make us 
better off. It takes careful analysis to discover how all this comes about— 
particularly so since the general assumption is that credit tends to make 
prices higher. To do so it will be necessary to revert to our distinction 
between credit and capital, (p. 227.) 

At least one prominent nineteenth century authority, Proudhon, by an 
elaborate system of reasoning attempted to show that properly organized 
credit institutions could provide free loans to everyone, do away with class 
distinctions which grow out of the existence of unequal incomes, eliminate 
all forms of private property, and even make unnecessary the very existence 
of government. This is a good illustration of the extremes to which some 


CREDIT 


261 


agitators may go when they base their programs of action on confusion of 
economic concepts. Proudhon’s main inconsistency was in not seeing the 
distinction between money and capital. He seemed to see very well the 
fact that credit might effectively substitute for money. It is, however, mainly 
through its effect on the available supply of capital that credit performs the 
wonders that it actually does perform. 

It will be recalled that we have defined credit as exchanges in terms of 
money without the use of money—"definite purchasing power without the 
use of money,” in the words of J. S. Mill. At no time has it been assumed 
that these exchanges are possible without the use of capital. Even the smallest 
credit transaction assumes the use of some capital. It is liquid capital, how¬ 
ever, that credit electrifies. 

In every civilized nation there are many persons who desire to set aside 
a portion of their income for the purposes of the future. Now, unfortunately, 
income will not keep. Money will retain its value longer than most other 
goods. But money does not increase in value. If there were no other plan of 
storing up a part of one’s income for the future than that of turning it into 
hard money, and hiding the money away, there is no question but that a great 
deal of hard money would be withdrawn from circulation, and society would 
suffer for it. Liquid capital may take the form of money, but it can just as 
well take the form of credit. 

Just as there are many persons who desire to set aside a part of their 
incomes so as to have something to live on in the future, there are many 
persons who wish to increase their incomes now by productive effort. The 
principal method of doing the latter is to enlarge their equipment—add 
more capital. It is these latter persons who need the purchasing power that is 
made available by the setting aside of the income by those who are looking 
for a future income without having to work. It is entirely possible for one to 
invest in his own business his own savings, and thus enlarge his income in 
that way. Usually, however, one is willing to receive a smaller income than 
to take the trouble and chances of loss involved in using one’s own savings 
in one’s own business. Persons of this kind turn their savings over to 
credit institutions, which, in turn, make them available for those persons 
who need purchasing power to use in their business. 

"A plough and its team of horses, in the hands of the ploughman,, 
enables him to produce much more corn than the labour of his hands alone. 
And it is this extra amount of corn that constitutes the so-called income of 
capital. None the less, it does not come from the plough, but from the man 
aided by the plough. The plough itself, too, comes from the labour of a 
man present or past. Those who see nothing in a plough but capital, may be 
reminded of the charming notion . . . that the inventor of the plough labours 
unseen by the ploughman’s side.” (Gide: Principles of Political Economy, p. 


262 


THE EXPANSION OF ECONOMIC CONCEPTS 


107.) The man who saves his purchasing power and turns it over to a 
bank places it where it can be borrowed by the man who needs the "plough” 
and hasn’t the purchasing power with which to secure it. 

Credit and the Interest Kate. —Those who have considered that the time 
element is essential to credit have naturally had difficulty in explaining the 
relation of credit to the interest rate. An example of that confusion is seen 
in the following quotation: 

"If Brown is less impatient for income than Jones, he will lend to the 
latter, but if more impatient, he will borrow; borrowing tends to lower the 
impatience of the borrower and raise it for the lender. Given a market of 
borrowers and lenders there will result a market rate about which borrowing 
and lending will crystallize. This rate measures the general notion as to how 
much, in a certain community at a certain time, present goods are preferred 
to future goods; it denotes, in other words, that lenders are willing to lend 
$100 today for $105 repaid one year later; the premium, 5%, is our market 
rate of interest. Whenever a credit is drawn, this element of time preference 
enters, and the value of the goods or the money returned at maturity must 
exceed the value of the goods or money originally paid. A borrower is willing 
to pay this premium for the use of the goods, or for money which repre¬ 
sents goods, for various reasons, but in any case the borrower must be 
satisfied that the goods are worth more to him (at the market rate of inter¬ 
est) than to the lender.” (Westerfield: Banking Principles and Practice, 
p. 39.) 

When one remembers that interest is paid for capital and not for credit, 
the inaccuracy in the above line of reasoning becomes apparent. Credit insti¬ 
tutions, however, do charge for their services of making capital available to 
those persons who have need of it. Where credit institutions are well worked 
out and coordinated, the flow of liquid capital becomes well regulated. This 
fact serves to make the interest rate more nearly uniform than is true of 
the price of most other economic goods. In other words, credit institutions, 
through which the economic law of supply and demand asserts itself with 
regard to the price that has to be paid for capital—the interest rate—serves 
their purpose well. A fuller development of this point will be made in a later 
chapter. 

The Relation of Credit to Prices. —We have already seen that the supply 
of wealth as a whole and prices do not always vary together. Prices may 
be rising while wealth may be constant or even increasing. On the other 
hand, prices may be falling without a corresponding increase in wealth. 
Generally, however, we expect falling prices to indicate increasing wealth 
and rising prices to indicate decreasing wealth. This would have to be true 
if prices were an exact gauge of value in exchange. 


CREDIT 


263 


Price changes may occur from forces other than those which affect value. 
These forces assert themselves with particular vigor in connection with 
credit. The command of credit, being a command of purchasing power, to 
any extent that it exists apart from the purchasing power evidenced by 
money proper has to have an influence, however small, on prices. 

It requires but little thought to discover the fact that the intervention 
of credit tends to increase production. Any force that makes goods and 
services more abundant increases wealth and lowers values. Credit certainly 
has that effect. The single fact that capital is made more readily available 
by credit is sufficient proof of that. Yet there are certain forces which tend 
to neutralize that benefit. Credit may be employed for the purpose of pur¬ 
chasing consumable goods. If, therefore, the use of credit to purchase con¬ 
sumptive goods exactly offsets the increase in production made possible by 
it, although human wants as a whole may be more nearly satisfied, values 
would remain unchanged. If the use of credit means that consumption is 
stimulated more than production, then goods would become less abundant, 
and living would become harder. 

The ideal use of credit would be that of increasing production while 
prices remained constant. It is, therefore, the abuse of credit instead of its 
use that makes prices rise as a consequence of the resort to it instead of 
money as an instrument of exchange. 

Pyramiding of Credit .—The phase of credit which is probably most 
influential on prices is that of pyramiding of credit. Credit pyramids, how¬ 
ever, are really inverted pyramids. 

Pyramiding of credit may be defined as the basing of a number of credit 
instruments on the same value. It appears in connection with many different 
phenomena. Clever financiers are sometimes so skillful in covering their 
tracks in this regard that it may be exceedingly hard to detect the fact that 
they have been resorting to the practice. 

If the author were called on to add another to the numerous explanations 
of business crises his explanation would be that business crises come as 
results of extended and sometimes relentless pyramiding of credit. 

It is comparatively easy to follow the processes of pyramiding of credit in 
certain fields of operation. A familiar instance appears in connection with 
land booms. Before the boom is launched the land values may be steady, and 
represent fairly well a capitalization of the rents. High pressure salesman¬ 
ship, however, may create a frenzied interest in land which will attribute to 
it an imaginary value far in excess of its real worth. Each lot sale carries a 
down payment and vendor’s lien notes representing unpaid balances. It is in 
connection with these unpaid balances that the phenomenon of pyramiding 
of credit is most evident. 


264 


THE EXPANSION OF ECONOMIC CONCEPTS 


Let us assume that there is a sale of a lot for $5,000—$1,000 down and 
vendor’s lien notes for the rest. If the values are accurately gauged the 
$4,000 in notes is a good basis for a loan at a bank. Other sales of the kind 
may be made. Soon land values begin to rise. Lots which formerly sold for, say, 
$5,000 may now be selling for $25,000. Credit institutions may become blind 
to the economic values underlying the credit structures. From now on sales 
may be for, say, $4,000 down and notes for the differences. The first buyers 
are now out of the transactions. They have made $4,000 for each $1,000 
previously invested. And so the process goes no. Astronomical figures may 
in time become representative of the land values carried in unpaid balances 
on vendor’s lien notes. In time, however, the structure has to break. When 
it does persons who have been attracted by the currents of inflated land 
values become stunned or even crazed by the explosion which they are 
unable to account for. The crisis is on. 

When the phenomenon of pyramiding of credit takes form in the securi¬ 
ties market it is much more subtle. In fact it is too complex for illustration 
here. Yet similar forces are at work which carry similar consequences. 

There must, however, of necessity be some pyramiding of credit. The 
expanding power of commercial-bank credit is traceable to the placing of 
several credit instruments on the same , money value. That is why a bank’s 
loans may be a multiple of its cash deposits. Yet when commercial banking 
institutions are well coordinated and wisely directed the expansion and con¬ 
traction of credit may serve to stabilize prices, by neutralizing the influence 
on prices of changes in the value of the standard money. 



t 


PART TWO 

f 

THE ECONOMICS OF PRODUCTION 


> 






CHAPTER I. 


SOCIAL INTEREST AS COMPARED WITH PRIVATE INTEREST. 
A RESTATEMENT. 

Wealth v. Value. —The importance of making the distinction between 
wealth and value has been alluded to many times in this study. Before launch¬ 
ing out into the analysis of production economics a critical re-examination 
of that distinction should be made. (See Part I, Chapter II.) The major 
thesis, however, is simply the fact that wealth is the result of abundance 
whereas value is the result of scarcity. 

It is due fundamentally to the fact that goods are scarce that produc¬ 
tive effort has to be exercised. Every productive act, instead of increasing 
value, tends to reduce value. Yet the less valuable goods are, the less willing 
men are to produce them. There is here conflict between private and social 
interest. At times this conflict seems to threaten the ultimate objective of 
productive activity—that of increasing social wealth. 

This conflict becomes evident in connection with the continually recur¬ 
ring effort to increase prices by reducing output. At times the movement 
becomes so widespread as to take the form of legislative enactment. Usually* 
however, the legislation sponsored by such a movement is nullified by court 
action. When producers of great commodities such as wheat and cotton 
agitate for the reduction of acreage merely for the effect on price they are 
attempting to increase their income at the expense of the rest of society. 
The same phenomenon appears in connection with agitation for shorter 
hours and higher pay by labor groups. Other instances of agitation sponsored 
by such a motive are ubiquitous. 

An easy way to see the fallacy of agitations of the kind is merely to ask 
ourselves what would be the effect if all of those efforts should succeed? 
What would happen if all producers reduced output for the purpose of 
raising the price of their goods and services? The answer comes immediately 
that if all economic goods and services were reduced in amount everybody 
would suffer. Although values (in use) would rise, prices would remain un¬ 
changed; for if all goods were reduced in equal amounts money also would 
be reduced in like quantity and prices would be unchanged. The fact is 
that a short cut could be taken to the same objective merely by increasing 


267 


268 


THE EXPANSION OF ECONOMIC CONCEPTS 


the amount of money. For then the prices would rise without the accompany¬ 
ing reduction in wealth. The experience of society with that kind of short 
cut has been so disastrous in the past that it is not likely that careful agitators 
will repeat the error. It is only when it appears that the reduction of the 
output of a certain commodity will not be accompanied by a corresponding 
reduction in the rest of them that producers accept the programs of reduc¬ 
tion of output. 

Among serious students of economic theory, however, the failure to see 
clearly the distinction between wealth and value has been fruitful of no little 
paradoxical theorizing. Not the least malicious has been the assumption that 
economic laws controlling production are less amenable to human control 
than are those relating to distribution. We hear a great deal of that among 
the Fabian socialists. Many years ago, however, J. S. Mill, in his later years, 
while assuming a compromising attitude toward socialism fell into the same 
error. A statement of the point as made by Mill will be best adapted to our 
study. After we have discovered the inaccuracy in his reasoning we can go 
from that to the discovery of the inaccuracy in the reasoning of other 
authorities. 

"The laws and conditions of the production of wealth partake of the 
character of physical truths. There is nothing optional or arbitrary in them 
... It is not so with the distribution of wealth. This is a matter of human 
institution solely. The things once there, mankind, individually or col¬ 
lectively, can do with them as they like.” ( Principles , Book II, Chap. I, 
Sec. 1.) 

As we proceed with our study and attempt to discover the laws which 
regulate production and distribution we shall find those which relate to 
distribution in many ways more complicated than those which relate to 
production. The two, however, are so tied into one another as to be well 
nigh inseparable. The only apology for treating the subject of production 
separately from that of distribution is that a better comprehension of 
economic theory can thus be secured. The subject has thus been approached 
ever since the time of J. B. Say. Even though it may result at times in less 
critical writers agitating for programs of social action clearly untenable, 
it is not likely that orthodox treatises on economics will discontinue the 
practice. 

In spite of all this we must recognize that under an order of economic 
freedom there exists a conflict between private and social interest that is both 
puzzling and unfortunate. Possibly the best that-we can do is recognize that 
the conflict exists and wherever possible foster the social interest even though 
fostering the social interest may at times mean a sacrifice of private interest. 
Progress, however, should not be heartless, and whenever practicable, agencies 


SOCIAL INTEREST 


269 


should be set on foot to heal the wounds of social progress. That should 
certainly be done when the remedies are not worse than the disease.* 

2. Difficulty of Measurement of Consumer Interest. —If it were 
possible to measure accurately both the consumer interest and the producer 
interest the problem of finding the correct adjustment between private and 
social interest would by no means be a baffling one. Without such a measure, 
however, we can without danger of contradiction state that in a contest 
between the two, in which each had opportunity to exert its full influence, 
there would be little question that the consumer interest would win. Let 
the consumers of beef become aggressively opposed to the policy of the meat 
packers. Let them effectively organize their own strength into slaughter 
houses of their own and the arrogant president of the private corporation 
will forthwith be humiliated. A similar thing can be said of the consumers 
of any article which may be freely reproduced. Commodities the production 
of which conforms to the law of monopoly price do not lend themselves so 
readily to the power of the organized consumers. Fortunately, however, there 
are not a great many of those commodities. Even in connection with 
monopolized commodities the law of substitution is a powerful weapon in the 
hands of the consumers. 

Consumers are, productively speaking, their own worst enemies. It needs 
to be observed that when consumers organize to control the production of 

'“‘'Note on the conflict of opinion with regard to the different application of economic laws 
of production, from that to distribution. v 

The conflict of opinion as to whether economic laws have the same bearing on distribution 
as they have on production seems largely traceable to difference in significance of terms. To the 
classical economists—in fact to all orthodox economists—the term distribution means simply 
the subdivision of the income among the agents of production. We have in this connection the 
law of rent, of wages, of interest, of profits, etc. Economists generally make little effort to go 
further than to account for each of these phenomena. When, however, certain authorities state 
that the same laws do not apply to distribution as to production they depart from the classical 
economists’ point of view. 

We may explain entirely to our satisfaction that in conformity with conditions under free 
competition wages are determined in a certain way. Yet the assumption of free competition is a 
bold assumption. Authorities who state that conditions relating to distribution are more 
amenable to social control than those relating to production are usually thinking of conditions 
under which economic freedom is non-existent. It was here that Sismondi registered his protest 
that has done service ever since his time. 

To Sismondi the fair price of labor existed only in the imagination of the economists. 
With him exploitation was the key-note of the automatic order. Exploitation existed whenever 
the employer took advantage of the workers’ ignorance, of their timidity, their weakness, or 
their isolation. He probably would have accepted as correct the economist’s theory of wages 
as it exists to-day. But he still would have said that exploitation is capable of being prevented 
by social action. 

The socialists, most of whom either consciously or unconsciously have based their phi¬ 
losophy on concepts developed by Sismondi, go further than Sismondi went in suggesting the 
remedy. With them exploitation is an organic defect of the automatic order. It is not confined 
to labor but applies to all payments which are sources of independent incomes. With them the 
only effective remedy is that of overthrowing the established order. In coming to that con¬ 
clusion, however, they have returned to the point of view of the classical economists in that 
they assume that production and distribution are both controlled by laws of equal strength. 
They, however, are unwilling to be held in the grip of those laws and want to make drastic 
changes in the whole social order so as to root out exploitation at its source. 



270 


THE EXPANSION OF ECONOMIC CONCEPTS 


the commodities which they desire, they no longer are merely consumers. 
They are producers as well. But when they, as consumers, enter the field of 
productive effort, no longer does the distinction between wealth and value 
show a conflict between private and social interest. The social interest and 
the productive interest are the same. The cheaper the good can be had the 
better for the consumer. It is no longer to consumer interest to have goods 
valuable. What they want is abundance. It is probably due to that one fact 
more than any other that the organized consumer is.so much more powerful 
than the organized producer. The blinding influence of the market no longer 
asserts itself between production and consumption. 

There are, however, several real handicaps in the way of the effectively 
organized consumers. They are: (1) The consumer power is unwieldy. As a 
group little if any community of interest exists among them. Few of them 
know one another in their economic interest as consumers. Any organ created 
to represent the consumer interest—except in time of stress—is likely to 
become either exploitative or inert. The power of the inert mass of con¬ 
sumers more nearly resembles the grinding power of a glacier than it does 
any of the dynamic forces. (2) Consumers are much given to yield to the 
mesmarismic influence of skillful salesman. A period of temporary cheapness 
will often win them from a course of action which in the long run would 
mean their ultimate good. It has become a noted fact in trade procedure 
that producers can for a time sell below cost for the purpose of "freezing 
out” less skillful sellers. In the end that procedure will most likely result 
in a higher price than would have been the case had the freezing out process 
not been successful. In other ways it is frequently possible for persons who 
are mainly "feathering their own nests” to tempt buyers away from con¬ 
sumer organizations whereas a more sensible procedure would have been 
to support those organizations. (3) Probably the most serious handicap of 
the consumer organization is the lack of initiative to take new ventures in 
productive effort. Consumers can, possibly, organize and take over the pro¬ 
duction and sale of a commodity already on the market. It is seriously to be 
doubted, however, that consumer organizations may ever be brought to 
exploit new methods of production so as to stimulate a continual rise in 
social wealth. Profits stand as a sort of prize offered to those persons who 
will find new ways of doing things which are cheaper and better. We have 
here at the same time the curse and the blessing of the competitive regime; 
it is a curse to those whose processes are superseded, and a blessing to the 
discoverer of the new process; ultimately, we believe that it is a blessing to 
the whole of society in that life is made more abundant and happier thereby. 
The conflict between private and social interest seems to have a way in the 
end of working out favorably to the social interest—continually sacrificing 
the private interest in spite of anything that it can do. 


SOCIAL INTEREST 


271 


In spite of these handicaps the power of the organized consumer remains 
an unmeasured and largely an untapped reserve of energy for social better¬ 
ment. Even when left uncontrolled it tends to support the ultimate good of 
the social whole. 

Consumer Organizations. —Where they have been developed consumer 
organizations assume mainly two forms. The one may be called consumer 
pressure leagues; the other, consumer business organizations. 

There is a multiplicity of consumer pressure leagues. Some of them are of 
lasting importance, but many are ephemeral in nature. Those of lasting im¬ 
portance subdivide into many groups. We find them organized mainly for 
political purposes, such as the famous Corn Law League sponsored by Richard 
Cobden and John Bright in England. Similar free trade leagues exist in most 
other countries but they have nowhere else done their work so well. Others 
exist for educational and moral purposes. Some are advisory in nature, 
putting their stamp of approval or disapproval on certain widely advertised 
goods. The consumer organizations of lasting importance which function 
merely as pressure leagues are by no means to be neglected as a social force. 
Many of them have done admirable service, and we may expect equally as 
significant contributions from them in the future. 

Ephemeral consumer organizations bob up and die out with price changes. 
Dissatisfaction with a sudden rise in the price of, say, milk, or meat, may 
take form in a consumers’ strike, or a consumers’ blacklist. Since the rise and 
fall of prices of most commodities are controlled by invisible forces which 
are beyond the reach of both producers and consumers, the influence of the 
ephemeral consumer leagues is of necessity of slight importance. 

In the consumer league plan of employing the power of organized con¬ 
sumers, while in many ways beneficial when effective, and sometimes of 
lasting benefit, the consumer interest and producer interest are so inter¬ 
mingled that only with great difficulty. can any of them be very effective. 
Consumers of shoes might be producers of leather, or consumers of clothing 
might be producers of cotton or wool. It is to their interest as consumers 
of clothing to have the price low, but not to their interest as producers of 
raw material to have the prices low. Hence the organizations tend to clash 
within themselves because of the conflicts of interest. It requires a philo¬ 
sophical analysis of the ultimate relation of production and consumption 
far beyond the attainment of the rank and file of members of such organiza¬ 
tions as these to m^ke them function well. The most that can be expected of 
them is the organization of consumers of certain definite commodities to be 
pitted against the organized producers, and a matching of strength in 
pressure for favors usually before legislatures. 


272 


THE EXPANSION OF ECONOMIC CONCEPTS 


Consumer Business Organizations appear mainly as cooperative associa¬ 
tions. Some persons who have studied the consumer cooperative organization 
have assumed them to be limited to the well-known cooperative stores or¬ 
ganized after the Rochdale model. It is true that all of them in a general 
way follow the model of the Rochdalers. But any- assumption that the con¬ 
sumer cooperative movement has been confined to the purchase of food 
products is wide of the truth. In some countries, as in England, it happens 
that the most phenomenal expansion of the consumer cooperative business 
organization has been in connection with food products. In other places 
the cooperative movement has never succeeded very well in connection with 
food products, whereas it has made great headway in other particulars. Take, 
as an illustration, the development, in America, of the participating form 
of the insurance policy, or the Building and Loan Association. Here consumer 
cooperation has had its greatest expansion in connection with finance. Funda¬ 
mentally, however, the results are the same. The consumer interest is kept 
distinct from the producer interest at least to the extent of not allowing 
a clash of agitations within its own ranks. 

To some writers the consumer codperative business organization makes 
a glowing appeal. That is particularly true of the venerable and most scholarly 
Professor Gide. He eulogizes it in the following language: 

"The task of reorganizing society belongs, not to the producers, but to the consumers, 
for while the former are inspired by the co-operative spirit, the latter are embued with en¬ 
thusiasm for the general well-being. Consumers have only to unite and all of their wants are 
satisfied just in the way they desire, for they can either buy directly from producers all they 
need, or they can, when they have become sufficiently rich and powerful, produce for them¬ 
selves in their own factories and on their own lands. This would mean the abolition of all 
profits, those of middlemen and manufacturers alike. The societies would retain only as much 
as would be necessary for further extension of the movement, returning all the rest to the 
consumers in proportion to the amount of their purchases. We have already had occasion to 
note how the idea of the abolition of profits had haunted John Stuart Mill, and how it seemed 
linked with an entirely new phase of social evolution, to which he gave the name of the 'station¬ 
ary State . 1 We have witnessed the Hedonists’ arrival at exactly the same conclusion, though 
along a directly opposite path, namely, that of absolutely free competition. 

"We must not lose sight of the fact that this revolution is accomplished without affecting 
the foundations of the social order—property, inheritance, interest, etc.—and without having 
recourse to any measure of expropriation save such as naturally results from the free play of 
present economic laws. Co-operators have no desire to interfere with accumulated capital, their 
aim being merely to form new capital which shall render the old useless. If existing capital is 
merely accumulated profits made out of labour, why should not labour itself make a profit, 
and this time keep it for its own use? 

"Complaints have been made that a system of this kind, even if it were realized, would 
not result in the abolition of the wage-earner, seeing that the workers would still be employed, 
the only difference being that their employer would be a society instead of an individual. The 
reply is that a person who works for a society of which he himself is a member is very near 
to being his own master. 

"Moreover, has anyone a right to raise this objection? The upholder of the present eco¬ 
nomic order certainly has not when we remember that he considers the wage contract to be 
the definite type of pure contract. Neither are collectivists entitled to make it, for under their 
system everybody would be a civil servant. Hence the only persons who are really justified in 
making this criticism are those who believe that the future will see an increase in the number 
of independent proprietors. The reply that we would make to them is this: The only hope of 
seeing this realized—which is also the ideal of some co-operators—is to set up producers’ asso- 


SOCIAL INTEREST 


273 


ciations under the control and protection of consumers’ societies. In fact, a regime of federated 
co-operative societies is not incompatible with the maintenance of a certain amount of auton¬ 
omous production, thanks to various considerations which need not be detailed here.” (Gide 
and Rist: History of Economic Doctrines, page 605, note). 

Fostering Care of Producer Interest.— The producer interest as dis¬ 
tinguished from that of the consumer does not lack for organized protective 
effort. Merely a summary of the agencies whose purpose it is to look out for 
the welfare of the producers is sufficient to show that. Almost any reader has 
had personal experience with such agencies. 

1. Direct Governmental Agencies. —The amount of money spent by the 
modern governments in protection of producer interest runs into astronomical 
figures. In this country, for instance, we have the Department of Agriculture 
with all of its concomitants. In addition comes to mind the recent activities 
of the Farm Board with its hundreds of millions of dollars to utilize in con¬ 
nection with farm relief. Hardly less important is the United States Depart¬ 
ment of Commerce. These departments, with all of their bureaus and offices 
are best thought of as gigantic efforts on the part of the government to assist 
constructively productive effort. 

2. Definite Legislative Enactments. —When we thing of definite legis¬ 
lative enactments naturally the great tariff walls surrounding the limits of 
most civilized nations come into mind. Tariff laws can only be accounted 
for by the fact that producer interests secure a grip on the legislatures of 
governments. Only to a limited extent does legislation follow logical analysis. 
The organized producers are able to convince the legislative bodies that their 
business will be jeopardized unless protected from the threat of foreign 
competition. The result is that consumer interest is extensively sacrificed to 
the purses of the protected producers. 

Less harmful but just as certainly legislative acts definitely to foster 
the interest of producers are bounties. Logically everything can be accom¬ 
plished by a bounty that can be accomplished by a protective tariff. But it 
is too evident what is happening. Money is taken directly out of the pockets 
of consumers and given to producers. The result is that the indirect method 
of accomplishing the same is chosen. Hence when bounties are offered they 
are usually to make sure that certain productive agencies exist that might 
not profitably exist without them. When appropriations for that purpose 
are made to appeal to the national pride of the people they raise very little 
protest. It is thus possible to secure immense subsidies for a nation’s merchant 
marine. The bounty, however, is not a popular device for fostering the 
producer interest. 

3. Chambers of Commerce. —There is hardly a city of any size in the 
land that does not proudly support its chamber of commerce. Likewise we 


274 


THE EXPANSION OF ECONOMIC CONCEPTS 


have district and statewide chambers of commerce. Even more spectacular is 
the national chamber of commerce. If one will examine critically the inner 
workings of these chambers of commerce he will find that they are promoted 
and supported almost exclusively by men of 'wealth who feel that their 
businesses will benefit by the services of these chambers of commerce. Only 
in very exceptional cases will one find a chamber of commerce putting the 
interest of consumers ahead of that of producers. 

4. Producer Alliances .—The very expression producer alliances brings to 
mind many gigantic efforts of producers to protect themselves. The most 
outstanding are: 

(1) Trusts and cartels. The first of these is especially characteristic of 
American business finance while the second appears in continental Europe. 
The description of these massive organizations is too involved to include at 
this point in our study. 

(2) Labor Unions. When we come to study labor as a factor in produc¬ 
tion we shall note the great significance of the organized labor movement. 
Laborers have joined by the millions in their effort to shorten the working 
day and increase wages. At times these organizations have seemed to threaten 
the very social order under which we are existing, sacrificing the rest of 
society to their own interest. The net result, however, seems to have been 
little more than to reduce somewhat the exploitative power of the organized 
employers. 

(3) Stock and Commodity Exchanges. We have already had occasion 
to allude to the organized exchanges in connection with market prices. How¬ 
ever indispensable they are, yet they are the products of organized producers, 
created better to find a market for their wares. 

(4) Farmers’ Associations. Not all farmer associations are strictly pro¬ 
ducer associations. Nevertheless the farmers have been active in sponsoring 
associations whose purpose is primarily to get a high price for their goods. 
The great producer cooperative associations—such as the California Fruit 
Growers Exchange—belong here. There are many others of less significance. 

When we contemplate the complexity and magnitude of these producer 
organizations we must stand in awe. Were it not for the fact that the con¬ 
sumer lies like a sleeping giant among pigmies we should despair of his 
fate amidst these conspirators. 

The Consumer Interest Not So Well Protected. —When we match 
the above array of producer organizations against the feeble efforts of con¬ 
sumers to organize and look out for themselves we can only conclude that 
the consumer interest is not so well protected. Yet there seems little reason 
why it should not be protected. 


SOCIAL INTEREST 


275 


Experience with such efforts as those embodied in pure food and drugs 
acts, in the legislation creating the Interstate Commerce Commission, and the 
Federal Trade Commission leads us to wonder why greater effort has not 
been made in that direction. 

The failure to develop consumer protective organizations is more easily 
explained than justified. 

In the first place because of the fact that producers and consumers are 
largely the same people it has been widely assumed that careful attention to 
producer interest would in and of itself result in consumer welfare. This 
reconciliation of producer and consumer welfare has been one of the principal 
causes of the glorification of the automatic order. 

Although Bastiat time and again called attention to the urgent need of 
looking at economic questions from the point of view of the consumer, yet 
he justified his belief in the economic harmonies under a system of free 
competition in the automatic subordination of producers to consumers. 

"The subordination of producer to consumer is nothing less than the 
subordination of private to general interest. Producers always consult their 
own interests, and are continually in search of profits. Still, everything in¬ 
vented with a view to increasing profits results in lowering prices, so that 
the consumer is the person who finally benefits by it. And economic laws, 
the law of competition and of value, constrain the producer who really 
wishes to be selfish to be altruistic, even despite himself. The laws outwit 
him, but his undoing benefits everyone else. While working for a maximum 
profit he is really toiling to satisfy the needs of others in the most economic 
fashion, and therein lies the harmony.” (Gide and Rist, p. 342.) 

The concept as presented by Bastiat is that which we find in practically 
every classical and neo-classical treatment of the subject. It appears so clearly 
to Professor Alfred Marshall that to him economic crises are merely tem¬ 
porary disruption of the credit structure. (See his Principles of Economics, 
p. 524.) 

But in another place Marshall is careful to advise more extended collection 
of statistics and other data for throwing more light on the problem of 
consumer welfare. (See Principles of Economics, p. 475.) This advice follows 
a profound analysis of the bearing of taxation and bounties in consumer sur¬ 
plus. Marshall finds that it is conceivably possible to increase human happiness 
by levying a tax on goods which obey the law of increasing expense and em¬ 
ploying the money thus raised to offer a bounty on goods which obey the 
law of increasing returns. Problems of that nature become entrancingly 
interesting after their significance has once been fully comprehended. 

It would seem that no problem could present a greater challenge to 
students of economics—in fact, students of most of the social sciences— 
than that of the discovery of ways to increase the happiness of mankind 


276 


THE EXPANSION OF ECONOMIC CONCEPTS 


through giving attention to the scientific aspects of consumer interest. There 
is hardly any social problem which is at this time receiving less attention 
at their hands. 

For our purposes, however, a full comprehension of questions such as 
these must first await an analysis of the factors, or agents of production. 
This analysis will claim our attention now. 



David Ricardo ( 1772 - 1822 ) 


"David Ricardo was descended from a Jewish family originally domiciled in Holland. 
He was born in 1772 in London, where his father had settled as a stock broker. He entered 
business a' an early age, and soon became thoroughly conversant with the intricacies of bank¬ 
ing and exchange. On the occasion of his marriage he changed his religion, and thus incurred 
the displeasure of his family. Setting up as a broker on his own account, he was not long in 
amassing a huge fortune, estimated at about £2,000,000—an enormous sum for those days. 

"Naturally enough, his earliest interest in economics centered round banking questions. The 
French wars had caused a depreciation in the value of the bank note, and this aroused the 
interest not only of the specialists, but also of the public. His first essay, published in 1810, 

















278 


THE EXPANSION OF ECONOMIC CONCEPTS 


when he was thirty-eight years of age, was entitled The High Trice of Bullion a Proof of the 
Depreciation of Bank Notes. It was soon followed by other studies dealing with banks and 
with the credit system. But these short polemical efforts gave scarcely any indication of the 
great attention which he was bestowing upon the principles of the science. His interest was 
primarily personal, for it appears that he had no intention of publishing anything on the 
subject. In 1817, however, the results were seen in a volume entitled The Principles of Political 
Economy. Ricardo the business man could hardly have guessed that it would shake the capital¬ 
istic edifice to its very foundations. 

"In 1819 he was elected a member of the House of Commons, but he was as indifferent 
a speaker as he was a writer. He was always listened to, however, with the greatest respect. 
'I have twice attempted to speak,’ he writes, 'but I proceeded in the most embarrassed manner: 
and I have no hope of conquering the alarm with which I am assailed the moment I hear the 
sound of my own voice.’ In 1821 he founded the Political Economy Club, the earliest of those 
numerous societies for the study of economic subjects which have since been established in 
every country. In 1822 he published a work on Protection to Agriculture. The following year 
he died, at the comparatively early age of fifty-one. 

"Since his death all his writings have been carefully collected, and his correspondence with 
the chief economists of his day, with Malthus, McCulloch, and Say, published. The corre 
spondence is extremely important for an understanding of his doctrines.” (Gide and Rist: 
History of Economic Doctrines, p. 189 note). 

It has often been stated that whereas Adam Smith’s major interest was in production that 
of Ricardo was in distribution. The accuracy of that statement must ever remain unchallenged. 
We are, however, placing the picture of Ricardo at this point in our study because of bis 
masterly contribution toward a better understanding of the place of land in the productive 
process. Before his day it was hazardous for anyone to challenge the privileged position of the 
landed proprietors. Ricardo so effectively threw them on the defensive that their position has 
Become increasingly insecure ever since. 


CHAPTER II. 


LAND AND OTHER NATURAL AGENTS 

In the early history of the science of economics it was not entirely clear 
what part was played by land in the productive process. We have already 
seen that the Physiocrats thought nature worked in a peculiar way with 
respect to the cultivation of land. Because of that fact the net product 
was possible. This net product was paid in the form of rentals to the land¬ 
lords, making it possible for them to live without having to work. 

Adam Smith was unable to break away from the Physiocratic point of 
view with regard to the peculiar part played by nature in agricultural pro¬ 
duction. In his famous hierarchy of the investment of capital he placed 
agriculture first because he assumed that there was a peculiar productivity 
of land devoted to agricultural production. Even Ricardo did not entirely 
break with the Physiocratic point of view with regard to land. It was evident 
in his analysis of the relation of land to value that he had in mind agricultural 
land. The further fact that he thought of rent only as relating to agri¬ 
cultural land indicated that in his mind agricultural production was of 
peculiar importance. 

Yet when Ricardo spoke of "the original and indestructible qualities of 
the land” as being the source of the contribution made by land in production 
Ricardo awakened thoughts on the subject that have continued to take 
form with greater and greater clearness ever since his day. We are safe in 
saying, therefore, that the advance in economic analysis made by Ricardo 
was phenomenal. In no longer considering the income from land as due to the 
abundance of nature, but instead to its niggardliness , he developed a concept 
that has been registered in practically every serious work in economic theory 
since his day. Only slowly, however, have the authorities come to appreciate 
clearly what part is actually placed by the forces of nature in production. 
With that exception, i. e., that the income that goes to the owners of land is 
traceable to the niggardliness of nature instead of its abundance, the authori¬ 
ties since the time of Ricardo present a mosaic of contradictory theses on 
the subject. 

To comprehend accurately the part played by land and other natural 
agents in production requires most careful thought. It was to be expected 


279 


280 


THE EXPANSION OF ECONOMIC CONCEPTS 


that early oconomists would see the phenomenon dimly. Even yet nature s 
contribution in each productive act is so commingled with other factors 
that a differentiation is only possible in the imagination. Yet a differentiation 
—in the imagination—is at least essential to its comprehension. Under the 
subject of distribution the differentiation becomes somewhat simplified. It is 
there that we shall be concerned with the explanation of rent. Apparently 
it is easier to understand a thing by examining its fruit than by examining 
the thing itself. 

At this point, however, the problem will be somewhat simplified by 
subdivision into (1) the part played by land itself from (2) the part played 
by other natural agents. 

The Part Played by Land in Production. —Since, as we have seen, 
it was Ricardo who first called attention to the fact that the value of land 
was due to the stinginess instead of the liberality of nature, and thus opened 
up the subject in its proper perspective, we shall present the Ricardian ap 
proach to the subject first. 

We have already noted that Ricardo was much concerned about a satis¬ 
factory explanation of value. He found it impossible to account for all evi¬ 
dences of value by the amount of labor expended on them. That was especially 
true in connection with the value of land. Some land, however, was clearly 
more valuable than it would have been had no labor been applied to it. 
Furthermore some lands had value without anything being done to them. 
Besides, lands with equal amounts of labor applied to them were not equally 
valuable. Ricardo concluded, therefore, that the value of land was due 
to its "original and indestructible qualities.” 

The illogicality of Ricardo’s explanation becomes apparent when we re¬ 
member that his purpose was to protect the labor theory of value by attribut¬ 
ing to nature the value of things to which labor had not been applied. 
A satisfactory explanation of value must account for value wherever it 
appears. If, therefore, land has value without labor being applied to it, it is 
rather the labor theory of value that is unsatisfactory than it is that the 
source of that value has to be explained without reference to labor. It is 
certainly not possible to support the labor theory of value by attributing 
to nature the value of something which has had no labor applied. 

The shortcoming of Ricardo’s analysis, therefore, becomes evident as a 
defense of his labor theory of value. In his search for a satisfactory explana¬ 
tion of value, however, Ricardo secured a glimpse of nature’s part in pro¬ 
duction. Based on this was developed the differential theory of rent, a theory 
that has done much service since his day, but one which stops somewhat short 
of the truth. 


LAND AND OTHER NATURAL AGENTS 


281 


Since Ricardo’s day thousands of pages have been written on the subject. 
It should be remembered that Ricardo was thinking only of agricultural 
lands. In his allusion to the original and indestructible qualities of the soil 
he had in mind merely fertility. The least fertile lands possessed no value. 
Those were divided into submarginal and marginal lands. Marginal lands were 
capable of being cultivated, but the returns were just enough to pay for the 
labor expended in working them. All lands above the marginal lands possessed 
value. They were valuable because they furnished an income to their owners 
above the cost of the labor and capital employed in working them. This in¬ 
come went to the proprietors. Only the good lands, therefore, were valuable, 
and their value was calculated by capitalizing the amount of the income 
above the cost of cultivation. 

Other authorities, notably von Thiinen, showed that remoteness from 
the market was as important a consideration in calculating the value of land 
as was fertility. Lands of equal fertility would have to be equidistant from 
the market to be equally valuable. That grew out of the fact that any 
superiority in fertility might be offset by an extra cost of transportation 
due to the greater distance from the market. With that exception hardly any 
advance was made over the Ricardian economics by the other classical 
economists. 

A few critics of the classical school, however, notably Carey and Bastiat 
—especially Carey—took Ricardo to task with regard to his interpretation 
of the part played by land in production. They could not see that land 
necessarily had any value. Value of land to them was merely an illusion. The 
part played by land in production was merely that of challenging human 
ingenuity in tapping its superabundant potentialities. In the philosophy of 
Carey and Bastiat, therefore, it was through the abundance of nature that 
land played its part in production. We can understand Carey and Bastiat 
better in connection with the law of diminishing returns. Carey and Bastiat 
really represented a return to the assumption made by Adam Smith with 
regard to the part that nature played in production. 

In neo-classical economics the concept of nature’s part in production is 
much more clearly presented. So much work has been done on the subject 
since Ricardo that there seems little reason for any careful student to fail 
to comprehend it. Yet there is a rather widely accepted thesis with regard 
to land among secondary authorities that needs to be called to mind. The 
thesis, in the opinion of the author, stops short of a full comprehension 
of nature’s part in production. To illustrate: 

"Professor Fetter seems to ignore this lesson in an article on 'The Passing of the Concept 
of Rent’ in the Quarterly Journal of Economics, May 1901, p. 419; where he argues that 'if 
only those things which owe nothing to labour are classed as land, and if it is then shown that 
there is no material thing in settled countries of which this can be said, it follows that every¬ 
thing must be classed as capital.’ Again he appears to have missed the true import of the 


282 


THE EXPANSION OF ECONOMIC CONCEPTS 


doctrines which he assails, when he argues (ib. pp. 423-9) against 'Extension as the funda¬ 
mental attribute of land, and the basis of rent.’ The fact is that extension (or rather the 
aggregate of 'its space relations’) is the chief, though not the only property of land, which 
causes the income derived from it (in an old country) to contain a large element of true rent, 
which exists in the income derived from land, or 'rent of land’ in the popular use of the term, 
is in practice so much more important than any others that it has given a special character to 
the historical development of the Theory of Rent (see above, p. 147). If Meteoric stones of 
absolute hardness, in high demand and incapable of increase, had played a more important part 
in the economic history of the world than land, then the elements of true rent which attracted 
the chief attention of students, would have been associated with the property of hardness; and 
this would have given a special tone and character to the development of the Theory of Rent. 
But neither extension nor hardness is a fundamental attribute of all things which yield a true 
rent. Professor Fetter seems to have missed the point of the central doctrine as to rents, quasi¬ 
rents and interest, given above.” (Marshall: Principles of Economics, p. 422, note). 

It must be apparent from the above that we are referring to the con¬ 
fusion of land with capital. We shall find that the effort to combine the 
two as a scientific concept becomes especially vicious when we attempt to 
distinguish interest from rent. It is as inaccurate to say that they are the 
same simply because they look alike under certain circumstances as it is to 
say that animal and plant life are the same because they look alike in their 
cellular form under the microscope. 

Other Natural Agents. —In modern economic analysis no longer is 
land dissociated from other natural agents except for purposes of more 
accurate exposition. The fact is that the real part played by even land as 
distinct from other natural agents in production can be better understood 
by centering our attention first on some other natural agent and then trans¬ 
ferring it to land. After the qualities of another natural agent where 
nature’s part is more clearly apparent are clearly apprehended it can be more 
readily understood that the same attributes apply to land, when completely 
dissociated from modifications made by the hand of man. 

As was well said by Dr. Marshall, the difficulty of understanding nature’s 
part in production grows out of the fact that nowhere is it entirely dif¬ 
ferentiated from other factors. "But economists have learnt to recognize 
diversity of nature in those composite things to which the names of rent, 
profits, wages, etc., are given in popular language; they have learnt that 
there is an element of true rent in the composite product that is commonly 
called wages, an element of true earnings in what is commonly called rent 
and so on. They have learnt in short to follow the example of the chemist 
who seeks for the true properties of each element; and who is thus prepared 
to deal with the common oxygen or soda of commerce, though containing 
admixtures of other elements.” (Principles, p. 421.) 

To discover the actual part played by nature in production Prof. Marshall 
develops an imaginary illustration as follows: 

"Let us suppose that a meteoric shower of a few thousand large stones harder than dia¬ 
monds fell all in one place; so that they were all picked up at once, and no amount of search 
could find any more. These stones, able to cut every material, would revolutionize many 
branches of industry; and owners of them would have a differential advantage in production. 


LAND AND OTHER NATURAL AGENTS 


28} 


that would afford a large producer’s surplus. This surplus would be governed wholly by the 
urgency and volume of the demand for their services on the one hand and the number of 
stones on the other hand: it could not be affected by the cost of obtaining a further supply,, 
because none could be had at any price.” {Ibid. p. 415). 

Since this point was made by Professor Marshall with the view of giving 
a satisfactory explanation of rent—the income which is derived from valuable 
natural agents—and since, in the opinion of the writer, Professor Marshall 
has made a real advance over other authorities in this particular, his con¬ 
tribution will receive more exhaustive treatment when we come to consider 
the subject of rent. 

From the above we can see that when economists began to consider 
nature’s part in production they thought of it only as asserting itself 
through the agency of land—in fact through agricultural land. After much 
concentration of effort, however, they have come to see the proposition 
in its pure attributes in spite of the fact that whenever it appears nature’s 
part is of necessity much confused with other influences. For the sake of 
clearness of exposition, however, it is highly desirable to study the forces 
of nature as they assert themselves in the working of land as distinct from 
their appearance in other categories. 

The Law of Diminishing Returns. —We have already seen (in Part I, 
Chapter III) that the groans of civilized humanity which accompanied the 
advent of the Malthusian theory of population might be taken as the birth- 
pains of the law of diminishing returns. Malthus, along with the other econo¬ 
mists of his time, thought only of means of subsistence as it related to agri¬ 
cultural production. For many years thereafter the law of diminishing returns 
was thought of only in that connection. It behooves us, therefore, to give 
attention to that aspect of the law first. 

As is true of most natural influences mankind felt the effects of the law 
of diminishing returns long before he discovered the law itself. The fact is 
that the great periods in the economic history of mankind—that of transition 
from the hunting to the pastoral stage, from the pastoral to the horticultural 
stage, from the horticultural to the agricultural stage, etc., can best be under¬ 
stood in the light of the operation of the law of diminishing returns. This 
law made itself felt through the pressure of population on the means of 
subsistence under each established method of making a living. 

To be more specific, it might be assumed that an average of, say, ten 
thousand acres of land per man, when man lives by the hunting stage, is 
essential to maintain the population. In a different stage, say the pastoral 
stage, less will be required. Let us assume that in this last instance an average 
of one thousand acres per man is sufficient. A similar assumption is possible 
for each of the great stages during the history of mankind. 

Now when the population reached the state of one for each ten thousand 
acres, or one for each thousand acres, as the case might be, some kind of an 


284 


THE EXPANSION OF ECONOMIC CONCEPTS 


outlet had to be found. At first tribes fought for the possession of the 
limited supply of land. Victory of one tribe over another only postponed 
for a time the occasion when the growth of population within the victorius 
tribes would reach the limit. Only when a new method of working the land 
appeared did anything like a satisfactory solution of the difficulty make 
its appearance. 

We can best understand the transition from one stage to another in the 
light of the operation of the law of diminishing returns. Stated simply, the 
law means merely that less and less can be realized from a given amount of 
land by working it more and more tediously. Each additional unit of capital 
and labor realizes a less and less proportional return. When one first begins 
to apply labor and capital the law does not become apparent. Doubling the 
amount labor and capital may secure more than twice the previous yield per 
unit. But very soon it becomes apparent that one must exercise great care 
in the expenditure of labor and capital to avoid spending more than the 
yield is worth. It becomes in the end a very nice problem to discover just 
what is the most profitable expenditure. The problem becomes a nice one 
because of the operation of the law of diminishing returns. 

The law, however, has other evidences. In the first place it appears ex¬ 
tensively as well as intensively. In the second place it is not limited in its 
operation to land. It applies as well to other natural agents. 

With regard to the first of these it is just as much a problem to know 
when to bring into cultivation other land, less fertile, of course, as it is to 
decide whether to work a given piece of land more intensively. There is a 
margin of indifference between the more intensive cultivation of a given 
spot of ground and the extension of effort to less fertile spots. When, 
however, the margin of indifference is reached it immediately becomes a 
question as to whether to bring into cultivation more land or to work 
harder that which is already under cultivation. The question is very easy 
to answer in theory for it really does not make any difference. Practically, 
however, a solution to the problem encounters many difficulties. 

All of this, however, assumes a different aspect if man discovers another 
method of operation. Fighting among the savages for the limited supply of 
hunting grounds might be accounted for as the concomitant of efforts to 
bring in "less fertile” lands. The substitution of pastoral life for that of 
hunting made fighting for the time being entirely useless. An analogous line 
of reasoning can be applied to any method of gaining subsistence from the 
land. If chemical synthesis should ever bring the substitution of the chemistry 
laboratory for the farm, the threatening contests of modern nations for 
world supremacy would very soon disappear. Whether or not the law of 
diminishing returns appears in the transition from one method to another 
will probably never be known. Some authorities, however, state categorically 


LAND AND OTHER NATURAL AGENTS 


285 


that it does. ''Whatever may be the future developments of the arts of agri¬ 
culture, a continued increase in the application of capital and labour to land 
must ultimately result in a diminution of the extra produce which can be 
obtained by a given extra amount of capital and labour.” (Marshall’s Prin¬ 
ciples of Economics , p. 15 3.) 

In connection with the dynamic aspects of the application of labor and 
capital to land, however, economists should speak with great caution. It 
is here that the work of Carey and Bastiat becomes so interesting. Whether 
or not the law of diminishing returns serves as anything more than a goad 
to human ingenuity in finding more fruitful means of tapping nature’s 
great reservoir is hard to say. 

The thesis advanced by Carey, a mid-nineteenth century American econo¬ 
mist, is that in working land man starts with the poorest land. The fertile 
valleys are so over-grown with vegetation that early settlers have to wait 
the coming of help before they can clear the valleys for cultivation. As 
population increases, however, it becomes possible for man to perform the 
more difficult tasks. An increase in population accompanied by a more minute 
division of labor, greater muscular energy, greater variety of intelligence, and 
more mental acumen, opens the way for greater and greater accomplishments. 
To Carey, therefore, the law of diminishing returns is little if anything more 
than an illusion. It is a limitation recognized only by the short-sighted—a 
challenge to men of ability. 

Bastiat, a contemporary of Carey’s who wrote in French, developed the 
same concept, although in a less scientific manner. 

The answers which have been given to the Carey and Bastiat concepts 
By different economists are interesting but not always convincing. 

"This theory, again, is open to the same objection as Ricardo’s. It applies to some cases 
only, and under certain conditions. Ricardo’s theory explained the facts relative to England, 
where population presses heavily upon the limited area of a small island already well occupied. 
Carey’s theory is equally well adapted to an immense continent, with thinly scattered popula¬ 
tion, occupying only a few cultivated islets amid the vast ocean of virgin forest and prairie. 
The two are not contradictory. They apply to two different sets of conditions, or to successive 
phases of economic evolution. And seeing that Ricardo’s applies to the more advanced stage of 
civilization, it certainly ought to have the last word. If Carey were writing now he would 
probably express himself somewhat differently, for it is no longer true even in the United 
States that the more fertile lands are still awaiting cultivation. Only the poorer and more arid 
plains remain uncultivated, and here dry farming has to be resorted to. So that even in the 
Tar West’ Ricardo’s theory is closer to the facts than Carey’s. Rents are rising everywhere, 
and not a few American millionaires owe their fortunes to this fact.” (Gide and Rist: History 
of Economic Doctrines, p. 339). 

It is very possible that Carey was writing with greater wisdom than he 
himself realized. He may have opened up a subject that will do greater 
service in the future than it has in the past. 

In conclusion we may say that the law of diminishing returns is a reality 
as long as we have not found the way to avoid its operation. Thus far in 
the history of mankind comparatively little headway has been made in re- 


286 


THE EXPANSION OF ECONOMIC CONCEPTS 


lieving mankind from its operation. But some headway has been made. It 
is possible—in fact even likely—that greater things may be done in the 
future. 

The advance already made, however, is in the mastery of those natural 
agents other than land. Beginning with the domestication of animals—the 
use of animal strength—man later harnessed the water-falls and the winds. 
After the lapse of many centuries he discovered the possibilities latent in 
the expansive power of steam, and with that the steam engine with its many 
uses and its multiplication of horse power. Subordinate to the steam engine 
has come the internal combustion engine. Then the wonders of electricity. 
What next we can hardly guess. It will probably take many centuries for 
man to come to enjoy all of the possibilities made available by discoveries 
already at hand. There may be sources of energy many times as powerful 
and many times as wonderful as those already brought under subjection. 
The contemplation of only one of them—that of atomic energy—makes one 
remark with Carey, truly,—man exploits the gentler of natural agents first. 

Yet there is another side to the picture. Man has certainly learned to live 
faster and to live closer together. But has he learned to live more abundantly? 
Has he materially reduced the average number of acres of land that are re¬ 
quired to feed a man? That there has been some reduction cannot be ques¬ 
tioned. But has the gain been in those portions of the earth where man has 
best succeeded in accelerating his motion and increased his load? The fact that 
larger weights can be carried at a time, and carried over greater distances 
certainly means an increase in wealth. But is it an increase that overrides 
the law of diminishing returns? To do that we shall have to add to the net 
yield of any given spot on the surface of the earth. As long as man feels 
the pressure of time and space in the production of means of subsistence— 
particularly of food products—he feels the presence of the law of diminish¬ 
ing returns. 

He may find a way to relieve himself of that pressure—time in that he 
may successfully accelerate the period of maturity of crops, and space in 
that he may grow them more abundantly (less laboriously) on the same 
spot. Already some progress has been made in that direction. But not enough 
as yet for us to say that the future of the human race is not materially 
hedged about by the law of diminishing returns. 

We have been informed that in laboratory experiments the use of the 
violet rays has accelerated the growth of plant life. We have also been in¬ 
formed that by planting certain crops in water instead of the soil, and by 
supplying the needed plant foods, temperature, and light, experimenters have 
succeeded in reducing the period of maturity surprisingly, and at the same 
time have greatly increased the size and quality of the fruit. Now, if ex¬ 
periments of that kind finally prove that this method of growing food 


LAND AND OTHER NATURAL AGENTS 


287 


products is less expensive per unit than older plans, then real progress will 
have been made in the direction of breaking the grip of the law of diminish¬ 
ing returns. 

Diminishing Returns v. Proportionality.— Owing to the fact that 
the law of diminishing returns has, in some instances, not been clearly dis¬ 
tinguished from at least two other phenomena very much like it, attention 
needs to be called to the distinction between it and that of proportionality. 
The following quotation from Professor F. A. Fetter is appropos: 

"Various meanings of diminishing returns. The chief other meanings given to the phrase 
law of diminishing returns, which must be deemed to be more or less confused or erroneous, 
will here be noted. 

"It is confused with the law of proportionality or with the law of enterpriser’s cost, 
especially as applied to the use of land in agriculture. The fact that a farmer can not profitably 
employ an unlimited amount of labor in any one year on a single acre is said to be due to the 
law of diminishing returns. A like application of the term is made in explaining the limitation 
in the use of land for other purposes, residence, etc. (see above, the principle of proportion¬ 
ality, ch. 12). This application is still further extended to the use of all other kinds of agents. 
Later an exacter criticism (notably Edwin Cannan, in 'Production and Distribution,’ 1894) 
has discerned that more than one problem is involved (which he called technical and historical 
diminishing returns). In our view there are at least three distinct problems: (1) technical 
proportion, the best mechanical or physical combination; (2) profitable proportion, the enter¬ 
priser’s best combination of factors at existing prices; (3) diminishing returns, the social- 
economic problem of the relation of population to resources. 

"The converse phrase, law of increasing returns, is applied to the economy of large pro¬ 
duction, especially in contmon contrast between manufacturing, said to be subject to the law 
of increasing returns, and farming, said to be subject to the law of decreasing returns. There 
is error here in every point. The manufacturing enterprise as it grows is assumed to enlarge the 
area of land, as it is needed (problem of investment in large production), whereas the farm is 
taken as a fixed area (problem of proportionality). This appears to have been first clearly 
pointed out by J. R. Commons in his 'Distribution of Wealth,’ 189J.” (Fetter’s Economic 
Principles, chapter 34, note at end of the chapter). 

The same idea as that advanced by Professor Fetter appears to have been 
more clearly stated by Pareto, who regards political economy as a study of 
the balance between desires and obstacles which stand in the way of their 
satisfaction: 

"Another problem of equilibrium is to discover the exact proportion in which the different 
elements combine in production. Jevons compares production to the infernal mixture which 
was boiled in their caldron by the witches in Macbeth. But the ingredients are not mixed hap¬ 
hazard, and Pareto thinks that they conform to a law analogous to that known in chemistry 
as the law of definite proportions, which determines that mollecules shall combine in certain 
proportions only. The combination of the productive factors is perhaps not quite so rigidly 
fixed as is the proportion of hydrogen and oxygen which goes to form water. Similar results, 
for example, may be obtained by employing more hand labour and less capital, or less hand 
labour and more capital. But there must be some certain proportion which will yield a maximum 
utility, and this maximum is obtainable in precisely the same way as in other cases of equi¬ 
librium—that is by varying the 'doses’ of capital and labour until the final utility in the case 
both of capital and labour becomes equal. Generally speaking, this is the law that puts a limit 
to indefinite expansion of industry, for whenever one element runs short, be it land or capital, 
labour or managing ability or markets, all the others are directly affected adversely and the 
undertaking as a whole becomes more difficult and less effective. Pareto rightly enough attaches 
the greatest importance to this law, and we have only to remember that it is the direct antith¬ 
esis of the famous law of accumulation of capital to realize its full significance. (Gide and 
Rist: History of Economic Doctrines, p. 53 6). 


288 


THE EXPANSION OF ECONOMIC CONCEPTS 


The quotations which have been given are included to show that the 
frequent categorical statement of the law of diminishing returns is open to 
some controversy. The assumptions made in those quotations, however, re¬ 
quire considerable refinement before they can be accepted as an accurate 
statement of a scientific principle. 

The first of these, that the law of diminishing returns should be con¬ 
sidered only as one evidence of the principle of proportionality, carries less 
of sanction to it than does the second, that a proportional return in quantity 
does not necessarily carry a proportional increase in value and price. 

The principle of proportionality simply means that there is a correct 
combination of factors in production to secure the greatest return. If there 
is a shortage of labor and abundance of capital, additional labor will be 
more profitable than would be the case if the reverse were true. The addi¬ 
tion of each increment of labor would net a decreasing return. One would 
not expect to double the output merely by doubling the labor if the amount 
of capital remained unchanged. Similarly for capital. If there is a shortage 
of capital it will pay to bring in additional amounts. Yet one could hardly 
expect to double the output merely by doubling the capital if the supply 
of labor remained unchanged. To secure the correct proportion of each factor 
should be the concern of every business man. 

When stated in these simple terms the proposition seems reasonable 
enough. But to establish a test of the correct proportion is more involved. 
It can readily be seen, however, that a correct ratio in one business would 
not likely be correct for another. Where hand labor predominates, as in the 
barber shop, there is need for an entirely different labor-to-capital ratio from 
that which exists in a textile mill. Yet it is clear to the least thoughtful that 
a barber without a certain amount of capital is helpless. Just how much 
capital should be invested for each barber is easier to answer in practice than 
in theory. A problem of similar nature exists in every productive under¬ 
taking. In more specialized studies of business the principle here noted is 
known as the law of balanced returns. Students of business finance assert 
that it is reasonably possible to find the correct ratio of labor to capital 
for practically any business undertaking. For some projects such as that of 
hydroelectric plants the capital investment becomes very large; while in such 
work as that of making fine watches the reverse is true, the labor factor 
being the most significant, and the plant small. Everywhere, however, there 
is a correct ratio for the most economic operation. 

Now to say that a similar calculation can be made for land begs the 
question. It is entirely possible to secure on the market whatever amount 
of the other factors that are needed to establish the correct ratio. It may 
be possible to secure the correct amount of a natural agent. Whether or not 
that will be possible will depend on an entirely different circumstance from 


LAND AND OTHER NATURAL AGENTS 


289 


that of securing other factors. A force of nature exists in amounts and with 
characteristics peculiar to itself. Man stands helpless before it. If only one 
unit exists and that is already employed another who might employ it profit¬ 
ably in his business has to go without it. It is between him and the other 
fellow. If he can make a bid more attractive than that which the natural 
agent is at this time yielding he might secure it. In that case the other 
fellow has to go without it. It is here that the law of diminishing returns 
makes itself felt. If it were possible for the utilization to net more and more 
both parties could work with the force of nature. The extent that anyone 
can go with it is limited by the fact that each additional application of 
capital and labor yields a less proportional return. 

The thesis that the law of diminishing returns is only a subdivision of 
that of proportionality is possibly accounted for by the fact that those hold¬ 
ing to it have not clearly distinguished between land (natural agents) and 
capital. The law of diminishing returns makes itself felt because of the 
fundamental characteristics of natural agents. They exist independently of 
anything that man can do and man has to make the most of them as they 
are. Effective proportionality means the utilization of other agents of pro¬ 
duction than land at the margin of indifference with relation to one another. 
The law of diminishing returns means getting the most out of a natural 
agent. If for any reason the correct proportion of other agents is not at 
hand, man can by taking thought secure more or less of any of them; natural 
agents are incapable of being increased or decreased by any known human 
agency. 

The other consideration, however, should always be kept in mind, lest 
we fall into serious error regarding the law of diminishing returns. It is not 
the value of the yield but the quantity that is meant. That is always funda¬ 
mentally true even though the only way that we can accurately measure 
the yield is in the terms of price. Whether we are speaking of the relation of 
the increase of horse-power to the speed of an engine, or the added doses 
of capital and labor to land it is the quantity of the product that we are 
striving for and not an increase in the value of that product. We have 
already seen that every productive act tends always to reduce value. Be¬ 
cause of that fact we must always fundamentally reckon the law of dimin¬ 
ishing returns in relation to quantity and not value. 

Fortunately an increase in amount will normally net a larger money 
return. It is only when there is a maladjustment of production to consump¬ 
tion that we encounter a lowering income as a result of an increase in pro¬ 
duction. Because of that fact whether we think in terms of price or quantity 
the same ultimate result obtains. 

With regard to the technical as distinguished from the historical aspect 
of the law of diminishing returns we refer again to Carey and Bastiat. 


290 


THE EXPANSION OF ECONOMIC CONCEPTS 


The Ownership of Natural Agents. (1) Agricultural lands, (a) The 
Transition to Private Ownership. —There was certainly a time in the past 
when no one owned agricultural lands—in fact land of any sort. Man’s legal 
relationship to land and other natural agents forms an interesting chapter in 
juridical history. A very concise statement of the evolution of private prop¬ 
erty in land follows: 

"Property has, at different stages in the development of civilization, been held in three 
distinct ways, corresponding to three different types of social philosophy: (1) anarchy; (2) 
communism or socialism; and (3) individualism. 

"(1) Under the anarchic system, things were regarded as the proper objects of temporary 
possession only, and not of permanent ownership. 

"(2) Under the communistic or socialistic system, the right of permanent ownership in 
things was recognized to be in organized groups of persons, but not in individuals. 

"(3) Individualism is the name applied to that social system in which things are regarded 
as capable of permanent ownership in individual persons. Things so owned or possessed are 
called collective, private or individual property; and so common has this form of ownership 
become in modern times that the right of private property takes its place among the funda¬ 
mental rights in rem. 

"The purely anarchic conception of property was confined to the primitive hords, and 
exists at the present day only among those tribes which are absolutely savage. Travelers have 
found absolute anarchy, so far as property is concerned, among the Veddahs of Ceylon, and 
the Bushmen of South Africa, and the inhabitants of Tierra del Fuego. It is supposed that 
communistic property was the next stage in the development toward individualism. Various 
attempts have been made in modern times to secure the adoption of a communistic system of 
property, but with little success so far as Christian nations are concerned. The property system 
of those North American Indian tribes which have not been strongly influenced by their con¬ 
tact with the whites seems, however, to be socialistic in nature. Modern civilization is based 
on private property. 'Just as men,’ says Montesquieu, 'have renounced their natural inde¬ 
pendence to live under political laws, they have also renounced the natural community of 
goods to live under civil laws. The former laws give them liberty; the latter property.’ ” (W. L. 
Clark’s Outlines for Review of the Fundamental Principles of the Law, pp. 77-78). 

The above summary although so worded as to apply to all private prop¬ 
erty really signifies mainly the coming of private property in land. The legal 
status of landed property, under modern governments, assumes many aspects 
different from that of personal property. 

(b) The United States Land Policy. —It is sometimes said that the United 
States has no land policy. The fact is that every organized government has 
to have a land policy. It may be merely a policy of inaction. Be that as it 
may, it is still a policy. The fact seems to be that many governments have 
not given critical attention to the land problem with the view of adapting 
its policy to the most desirable social ends. That is probably what is meant 
when it is said that the United States has no land policy. 

In the United States within a comparatively short period of time we have 
experienced the transition from free land to that of lands of great value. 
Possibly nowhere else has there been as good a place to view the operation of 
economic laws with regard to ownership and cultivation of land as in the 
United States during the nineteenth century. 

(c) The Virtues and Defects of Private Ownership of Agricultural 
Land. We have set for ourselves the proposition of taking up later in this 


LAND AND OTHER NATURAL AGENTS 


291 


study a fuller consideration of the land problems than can be given at this 
point. This fuller consideration cannot be given intelligently without first 
gaining a clear understanding of rent. A few of the preliminary considera¬ 
tions can be noted here. 

Ownership of land by one person precludes the ownership by another. 
Since land is limited in supply and since its supply is not capable of being 
increased by the hand of man, however much one may envy his neighbor a 
farm that his neighbor owns he cannot go into the market and duplicate 
it. A similar statement cannot be made of a great many other commodities. 
There are a few, such as the works of a dead artist. But even these may be 
so well copied as to carry almost equally as great esthetic satisfaction. Not 
so with land. The ownership by one person of any particular spot on the 
face of the earth precludes its ownership by anyone else. 

Of course, under many circumstances, the above fact is not of great sig¬ 
nificance. In connection with agricultural land it is true that there are many 
farms nearly enough of equal fertility and nearness to the market not to 
matter very much. Not until after all the better lands are taken does the 
inability to increase the supply of the most desirable farms make itself felt 
harmfuly. But when once all the better lands have been appropriated those 
who have been left out feel the effect of the fact that the supply of land 
is limited by nature. 

Consequences of the operation of the principle here noted are such as to 
sometimes make one question the social desirability of private ownership of 
farm lands. The most outstanding consequence is the fact that the owners of 
the better lands, after once they have secured them, whenever the popula¬ 
tion increases up to the point that it becomes profitable to work less desirable 
lands, begin to "rent their land out”. There tends to become established, on 
the less fertile land, a standard of living, on the part of those who work 
these lands, determined by the normal income from them. It, therefore, 
becomes a matter of indifference to them whether they work the poorer 
land as owners, or rent the better lands and pay the difference between the 
income from the poorer lands and that of the better lands in the form of 
rents. It becomes possible, therefore, for owners of the better lands to live on 
the rents, whenever the difference yields a sum large enough to support 
them. Since they live on an income which results purely from a cause inde¬ 
pendent of their productive effort, serious students of social problems may 
well question their right to that income. 

But the fact that landed proprietors are able to live without working is 
not the only—possibly not the worst consequence—of an unregulated private 
ownership of land. The proper husbanding of nature’s gifts also comes into 
question. The main considerations here are (1) the virtues of the owner- 
operator, and (2) the jeopardy of scientific agriculture. 


292 


THE EXPANSION OF ECONOMIC CONCEPTS 


The Owner-Operator. —Probably no statement is more frequently quoted 
than that of Arthur Young’s that in agriculture private ownership of lands 
turns sand into gold. A more poetic expression appears in the following 
utterance of Michelet: the peasant proprietor "thirty paces off stops short 
and turning round, throws a last look on his land, profound and sombre, but 
for one who has eyes to see, full of passion, feeling, and devotion.” (Quoted 
in Gide’s Political Economy, p. 520 note.) 

But compare that with the following utterance of the eminent English 
authority: " 'The magic of property turns sand into gold,’ said Arthur 
Young. It undoubtedly has done so in many cases in which the proprietors 
have been men of exceptional energy. But such men might perhaps have done 
as well or better if their horizon had not been limited to the narrow hopes of 
a peasant proprietor. For indeed there is another side to the picture. 'Land’, 
we are told, 'is the best savings-bank for the working man’. Sometimes it 
is the second best. But the very best is the energy of himself and his chil¬ 
dren; and the peasant proprietors are so intent on their land that they often 
care for little else. Many, even of the richest of them, stint the food of them¬ 
selves and their families; they pride themselves on the respectability of their 
houses and furniture; but they live in their kitchens for economy, and are 
practically worse housed and far worse fed than the better class of English 
cottagers. And the poorest of them work hard during very long hours; 
but they do not get through much work, because they feed themselves worse 
than the poorest English labourers. They do not understand that wealth is 
useful only as a means toward a real income of happiness; they sacrifice 
the end to the means.” (Marshall: Principles of Economics, p. 646.) 

Mere sentiment is of but small importance in the solution of an economic 
problem. The evidence is overwhelming with regard to the fact that the 
owner-operator is the most satisfactory system of husbanding agricultural 
land. Unfortunately, however, private ownership as such does not necessarily 
result in owner-operators. It tends to fix the owners on the less fertile lands, 
but the better lands tend to be held by persons who desire to live on an 
independent income. The joys of a dependable income make the temptation 
too great, when the possibility exists, for the owner to lease his lands out and 
live on the rentals. All too frequently, therefore, private ownership defeats 
its own ends by bringing about separation of ownership from operation. 
Unless something is done by society as a whole to forestall that tendency we 
may well fear the future consequences, both with regard to the ability of the 
proprietors to continue indefinitely to derive an income large enough on 
which to live, and the ability of the population to rely on a satisfactory 
supply of farm products. This, however, is probably not the most serious 
consequence of the separation q{ ownership from operation. Another much 


LAND AND OTHER NATURAL AGENTS 


293 


more to be dreaded is the effect on agricultural progress through the utiliza¬ 
tion of scientific information in connection with agricultural production. 

Private Ownership and Scientific Agriculture .—The fact that scientific 
agriculture results in greater production per unit of land can mean only one 
thing for the man who is striving to live on rents. Greater productivity 
per acre means less value to the better lands. "Every advance in agricultural 
science must mean more products from the same amount of land and a check 
upon the law of diminishing returns, resulting in lower prices and reduced 
rents, since it would no longer be necessary to cultivate the poorer soils. In a 
word, since rent is measured by reference to the obstacles which thwart cul¬ 
tivation, just as the level of water in a pond is determined by the height 
of the sluice, everything that tends to lower this obstacle must reduce 
rent. In mitigation of this charge it must, however, be noted that, taken 
individually, every proprietor is of necessity interested in agricultural im¬ 
provement, because he may have an opportunity of benefitting by larger 
crops before the improvements have become general enough to lower prices 
and to push back the margin of cultivation. If every proprietor argued in 
this way, individual interest would finally cheat itself, to the advantage of 
the general public. But this is nothing to be proud of.” (Gide and Rist: 
History of Economic Doctrines, p. 15 3.) 

If the owners of the farms were at the same time the operators, logically, 
the result of improved methods of production would mean larger incomes 
to the farmers. That would happen because of the fact that less effort would 
have to be exerted to gain as great an income as before. 

(2) Forests .—The same justification for the retention of private owner¬ 
ship of forests does not seem to exist as that for the retention of the private 
ownership of agricultural land. This is so in spite of the fact that there are 
found instances in which large corporations have bought up extensive 
forest areas and have consciously worked out a plan of balancing the yearly 
cut against the yearly growth. Whenever the owner of a forest thus balanced 
is able to realize an income above the expenses incurred in exploiting the 
yearly cut his income is not different from that of the absentee agricultural 
landed proprietor. Nature is furnishing the income without the owner, him¬ 
self, having to do anything about it. 

One should certainly hesitate a long time, however, before one would 
say that private owners of land should not have the income derived from 
trees grown under his care. The love of growing trees is certainly one of the 
finest impulses of humanity. Whenever and wherever that love is apparent 
it should certainly be fostered by social agencies. If that agency needs to be 
the private ownership of the lands and trees then private ownership it should 
be. 


294 


THE EXPANSION OF ECONOMIC CONCEPTS 


Yet the great devotee of laissez faire —Adam Smith—was careful to 
count the care of the forests as one of the things left for the government 
to do. Smith’s reason for this exception was that "it could never be for the 
interest of any individual, or small number of individuals to maintain them 
because the profit could never repay the expense to any individual or small 
number of individuals, though it may frequently do much more than repay 
it to a great society.” Smith thought, therefore, that private initiative could 
not be allowed to run its course in connection with the forests. Bitter experi¬ 
ence is beginning to show that the Smith thesis is correct. 

Aside from the development of State and national forests, which are 
usually sections of land set aside as much for their scenic beauty as for the 
preservation of the forests, not a great deal of progress has been in this 
country in the direction of promoting reforestation and in restricting the 
wanton destruction of trees by the owners. It seems, however, that in the 
near future all progressive nations will have to do for trees what they have 
already done for the wild animals, i. e., limit the right of exploitation even 
on one’s own land. The fact that the periods of growth and death of most 
trees are much longer than the life of any particular individual human being 
almost forces the interest of society in the preservation of trees to over¬ 
shadow any man’s right to destroy them. The sooner we come to a policy of 
establishing terms and conditions according to which persons must conform 
in cutting trees even on their own land the better it will be for society. 
If that policy be accompanied by a plan of social assistance to those who are 
willing to plant and foster forest growth the day of forest conservation may 
be said to have dawned. 

(3) Urban Lands .—The ownership of lands in cities assumes a number 
of aspects different from that of the ownership of agricultural lands. Cities 
have so many different reasons for their development and large cities have so 
many varieties of land problems that it is hard to generalize about them. 
There are, however, a few facts that are outstanding. Some of them are: 
(a) In most cities, with the possible exception of residence property, only 
a few persons own a greater part of the land. These persons, of keen business 
judgment, have bought them up at a sacrifice or have held them from a time 
when land values were lower, (b) The virtues of private ownership which 
relate to the better husbanding of nature’s part in the productive process seem 
not to apply with as great significance to urban lands as to agricultural 
lands. Each of these propositions has an important bearing on a wise govern¬ 
mental policy toward urban lands. 

With regard to the first point, if the interest of only a small number 
of people is at stake, in a city which has a democratic form of government, 
the problem of social sanction of a far-reaching policy toward the lands 


LAND AND OTHER NATURAL AGENTS 


295 


becomes very much simplified. If a few people are blocking the develop¬ 
ment of a town, the organized whole along a constructive plan of action 
should be able to remove the obstacle. Instances are many when one or two 
men—veritable land hogs—stand like dogs in a manger in the way of the 
best interest of the whole town. When a situation like that prevails the vir¬ 
tues of private ownership no longer exist. 

With regard to the second, the shop-keepers and factories usually hold 
their sites under some sort of a lease. Even when they own their buildings 
they have usually been constructed on leased land. Their own business 
ability contributes to the income of the owner of the land on which the 
building is constructed. It is hard to see that if the rentals were paid to the 
city instead of to the landowners that very much loss would be experienced 
in the utilization of the spot on which the business exists. 

(4) Subsurface Rights .—The principal subsurface commodities are of 
course, minerals, oils and gases. All of these possess practically the same 
characteristics of having their supplies limited. At least thus far in human 
experience no way has been found to replace artificially any of those provis¬ 
ions of nature, sufficiently cheaply to be of economic importance. This fact 
bears with special weight on the question of private ownership of these 
commodities. It takes very little reflection to discern that the right to a spon¬ 
taneous supply of mineral water which bubbles out of the ground is a differ¬ 
ent problem from that of a right to an oil well. The rate at which the 
mineral spring dissolves the mineral deposit through which it flows makes 
it for our purposes an inexhaustible source of utility. The same cannot be 
said of the reserves of oil and gas, and the deposits of ores, coal, etc. When¬ 
ever these last articles have been used up, unless perchance research has found 
a way for humanity to do without them, we shall suffer for the lack of 
them. Calculations which have been made with regard to the durability of 
the known deposits of most of these commodities are certainly cause for a 
searching of hearts. 

Two different policies are followed by civilized nations with regard to 
subsurface rights. The one—applicable generally to English-speaking coun¬ 
tries—is that he who owns land owns it all the way to the center of the 
earth below and to the sky above. Where that policy exists, the landowner 
has an unquestioned right to all minerals, oils, gases, etc., that are found 
under his land. It thus becomes very much to the interest of the landowner to 
discover one of these deposits on his land. Associated with land ownership 
thereupon exists a complicated, cumbersome, and composite system of con¬ 
tracts and leases of land for the purposes of prospecting for and exploiting 
of the natural subsurface resources. They are drawn off and marketed with 
little thought of the future. Much waste develops from the fact that the 


296 


THE EXPANSION OF ECONOMIC CONCEPTS 


most profitable use to the individual is not always the one most advantage¬ 
ous to society as a whole. Yet we go blindly on hoping for the best without 
any logical basis for that hope, making millionaires of the lucky individuals 
who happen to own the land on which oil and minerals are found. We are 
almost certainly enriching the private individuals to the detriment of our 
progeny. 

The other policy is that followed by France and Spain, and by powers 
developed under their sway. Here private ownership of land relates only to 
top-surface. Subsurface deposits belong to the state. Where that policy pre¬ 
vails a much more deliberate plan of tapping the subsurface reservoirs of 

wealth can be worked out. As yet, however, we are unable to say that in all 

instances the results which have been attained in those countries are very 
much more encouraging. Where they have fallen short of a more enlightened 
policy, however, the explanation seems to be in the fact of the existence of 
a poor government itself rather than the different economic policy. 

(5) Water Power. —Not less significant than other parts played by 

natural agents in production is that of water power. In fact water power was 

one of the earliest of the forces of nature to be harnessed by man. In our 
own times, however, it has taken on special significance owing to its adapta¬ 
tion to the production of electricity. Before the development of the radio, 
water power was possibly the nearest approach to a natural agent that sup¬ 
plied services which were clearly separable from those of other agencies 
employed to attain their utilization. This becomes apparent when we see that 
some water falls are of small value even though they are capable of just as 
great generative power for the making of electricity as others, more favor¬ 
ably located, which have great value. The calculation of the value of these 
water power sites, independently of the value of the equipment necessary to 
bring them into production of electricity is a determinable problem. It, how¬ 
ever, offers many complexisites. These can better be understood in connection 
with the subject of rent. 

(6) Radio Waves .—At last we have, in the radio wave, a clear evidence 
of a point long made by economists, i. e., nature’s part in production should 
be, for scientific purposes, kept clearly differentiated from other factors. 
We have here a phenomenon that conforms well night perfectly to the 
economist’s concept of a natural phenomenon which has value and possesses 
other attributes which distinguish it from other factors in production. The 
popualr term "frequency” describes the thing about which we are now 
concerned. How much would a broadcasting station be willing to pay for the 
exclusive and unalloyed right to broadcast over one of these "frequencies?” 
The fact that they are limited in number makes it possible that no one 


LAND AND OTHER NATURAL AGENTS 


297 


commercial station be given that right. The pressure for the right to broad¬ 
cast gives each of these "frequencies” greater value. 

We have here something that has no cost of production. It is certainly 
indestructible, and we are told by electricians that there is such little differ¬ 
ence among the various "frequencies” as to give each channel equal value to 
the rest. Once and for all we can see that if "all land were alike” there might 
still be rent. 

We are told that there are fewer than a hundred possible clear channels 
with the present known methods of broadcasting. The number of agencies 
desiring to make use of these channels runs into the thousands. To gain a 
modicum of decency in reception governments have had to establish radio 
commissions with broad powers of licensing of broadcasting stations. The 
newness of the problem has led to interesting decisions by these commissions. 
The fact is that they are dealing with a thing which possesses characteristics 
materially different from anything which the world has seen before. The 
results thus far attained do credit to these men. A careful consideration of 
the radio wave as a natural agent which possesses the attributes long known 
to the best economists would go a long way in the direction of the laying of 
the foundation for the solution of a vexing problem. 

Knowledge of Rent Essentials to the Comprehension of the 
Value of a Natural Agent. —The writer has not assumed that he has 
mentioned every phenomenon that possesses characteristics attributed to 
forces of nature. The fact is they are myriad in number. For the sake of see¬ 
ing more clearly the part played by these forces a very simple illustration will 
better serve our purpose. 

Let us take, as an illustration, the problem of the valuation of a thing 
such as the bricks of commerce. There are many kinds of bricks. Some are 
made of common clay and others are made of rare deposits of clay. No par¬ 
ticular difference in the expense of manufacture need occur for there to be 
a difference in value of bricks. Bricks made of, say, fire-clay have a greater 
value than bricks made of common clay even though no more expense be 
incurred in the manufacture of the former than the latter. If the same 
person owned a deposit of common clay and also a deposit of fire-clay, he 
would find that almost nothing could be had for the common clay, while 
the fire-clay might be a source of a handsome return. In neither instance 
would the owner need to exert himself to gain the price of the product. The 
difference in the value of the two sorts of bricks is traceable to a phenome¬ 
non which gives rise to that illusive thing which has come in economics to 
be known as rent. 

The value of bricks made of fire-clay in excess of the value of those 
made of common clay, although traceable to the part performed by nature in 


298 


THE EXPANSION OF ECONOMIC CONCEPTS 


production, and although in fact rent, possesses certain characteristics not 
attributed to pure rent. Owing to the exhaustibility of the deposits of fire¬ 
clay the value of these deposits is materially different from the value of a 
radio wave. The distinction here noted calls for a refinement of thought 
seldom made by economists, but one essential to careful analysis. 

In connection with the phenomenon of rent Professor Marshall has care¬ 
fully pointed out that there are three phases of that income. The one is that 
of quasi-rent, which is in fact not rent at all, but something that looks very 
much like rent. It goes to owners of durable capital goods. During an inter¬ 
val of time involved in the creation of more capital goods capital once 
invested may be earning more than the commercial rate of interest. The fact 
of the durability of capital goods may, therefore, be responsible for an 
income which cannot be called interest. It can hardly be called any of the 
other of the incomes; so Marshall dubbs it quasi-rent. 

Closely related to that is the income from a natural agent which is not 
indestructible. Clearly the value of a destructible natural agent is relatively 
less than the value of an indestructible one. Professor Marshall calls attention 
to the fact that the phenomenon here is different from that of pure rent. 
Pure rent is attributable only to natural agents which are at the same time 
valuable and indestructible. The income, therefore, which goes to the owner 
of fire-clay is different from the income which goes to one who may own 
a water-fall, or, if you please, a radio wave. The one cannot endure longer 
than the supply of fire-clay; the other will last for ever. At least the loss of 
the income cannot be attributed to any wastage of the natural agent itself. 
Professor Marshall points out that the income from a destructible natural 
agent should better be called royalty than rent. 

Fire-clay and common-clay, therefore, are not first-class examples of 
sources of income known as pure rents. They serve the purpose well, how¬ 
ever, in that they stand, as it were, half way between quasi-rents and pure 
rents, both of which concepts are essential to a full comprehension of the 
problem of rents. A closer view of each of these fundamental concepts as 
well as several others that grow out of them will be given more critical atten¬ 
tion in their proper place in this study. 

Men are constantly in search of a source of independent income. They 
want to feel that they can live without working if the occasion should 
demand. Now, there are several sources of independent income. Yet no source 
of independent income is quite as attractive as that of rent. It comes almost 
like manna from the skies. The possessor of that.source of income comes to 
feel that he is, somehow, a pet of Providence. As long as society allows him 
to remain unmolested it is hard for a student of economics to see that the 
one who lives on such an income is not something of a pet of society. 


LAND AND OTHER NATURAL AGENTS 


299 


Although we may conclude that under certain conditions it is highly desir¬ 
able that the owner of a natural agent be allowed to enjoy the income made 
possible to him because of that fact, yet to the extent that his income is 
traceable to pure rent he is still a social pet. 

It is hardly accurate to say that the mere fact of private ownership of a 
natural agent is enough to justify the owner’s right to the income made 
possible by that ownership. Unless the social purposes are better served by 
allowing private individuals to draw that income, it is seriously to be ques¬ 
tioned whether the mere fact of private ownership is enough to justify one’s 
right to an income from a valuable natural agent. Questions of this nature 
will receive more extended treatment in connection with the projected solu¬ 
tion of the land problem. 







k 



























Charles Fourier ( 1772 - 1837 ) 

"To some writers Fourier is simply a madman, and it is difficult not to acquiesce in the 
description when we recall the many extravagances that disfigure his work, which even his 
most faithful disciples can only explain by giving them some symbolic meaning of which we 
may be certain Fourier would never have thought. The term 'bourgeois socialist’ seems to 
describe him fairly accurately, but its employment lays us open to the charge of using a term 
that he himself would never have recognized. But what are we to make of one who speaks 
of Owen’s communistic scheme as being so pitiable as to be hardly worth refuting; who 
"shudders to think of the Saint Simonians and of all their monstrocities, especially their decla- 


301 






























302 


THE EXPANSION OF ECONOMIC CONCEPTS 


mations against property and hereditary rights—and all this in the nineteenth centry’; who in 
his scheme of distribution scarcely drew any distinction between labour, capital, and business 
ability, five-twelfths of the product being given to labour, four-twelfths to capital (which is 
probably more than it gets to-day), and three-twelfths to management; who outbid the most 
brazen-faced company promoter by offering a dividend of 30 to 3 6 per cent, or for those who 
preferred it a fixed interest of 8 per cent, who held up the right of inheritance as one of the 
chief attractions that would be secured by the Phalanstere; and who finally declared that 
inequality of wealth and 'even poverty are of divine ordination, and consequently must forever 
remain, since everything that God has ordained is as it ought to be?’ 

"To the men of his time, and to every one who has not read him, which means practically 
everybody, Fourier appears as an ultra-socialist or communist. That opinion is founded not so 
much upon the extravagance of his view or the hyperbolical character of his writing as upon 
the popular conception of the Phalanstere, which was the name bestowed upon the new associa¬ 
tion he was going to create. Visions of a strange, bewildering city where the honour of women 
as well as the ownership of goods would be held as common property are conjured up at the 
mention of the word.” (Gide and Rist: "History of Economic Doctrines, pp. 245-6). 

It may appear to the reader that the author has given too prominent a place to a queer 
personality. Closer appreciation of the import of his logic, however, reveals the fact that 
Fourier had almost an uncanny power of divining the future. At any rate he has the distinction 
of having contributed that which we have chosen to call the second law of labor, viz., that the 
irksomeness of labor varies directly with constraint and inversely with freedom. Comparatively 
few authorities on economics include that law. In the opinion of the author failure to include 
that law in treating labor as a factor in production is a serious omission. 


CHAPTER III. 


LABOR IN THE PRODUCTIVE PROCESS 

When we consider the relative poverty of society, and the further fact 
that it is mainly through work that man secures the wherewithal to satisfy 
his wants, it would seem that never should anyone who is willing and able 
to work be without something to do. Yet we are almost constantly faced 
with a great army of unemployed—persons eager and willing to work who 
spend much of their lives in want primarily because of their inability to 
secure jobs. From this it appears that when we approach the economics of 
labor’s part in the productive process, unless we approach it with conscious¬ 
ness of the magnitude of the problem, we are unlikely to do justice to the 
phenomenon under consideration. 

It is not surprising that the early economists did better in explaining the 
part played by land in production than they did in explaining the part played 
by labor. In spite of the illusiveness of the phenomenon of rent and its con¬ 
comitant, that of natural "agents, the comprehension of the economic laws 
controlling that phenomenon is a much less complex proposition than that of 
labor. 

During the first fifty years of the science of economics we find very 
little constructive work done in the way of developing a scientific approach 
to labor problems. The problems, however, existed in more acute forms than 
was true even in earlier periods. Yet very little was done in the way of com¬ 
ing to an understanding of the scientific principles essential to a wise pro¬ 
gram of social action. 

Since the labor factor cannot be entirely dissociated from labor’s part— 
that of wages—it will be impossible entirely to dissociate these two concepts 
for the purpose of analytical treatment. It is necessary, however, for us to 
gain the outstanding attributes of labor as a factor in production before we 
undertake the making of a critical study of the theory of wages. In this 
chapter our concern will be with labor as a factor in production, with only 
casual allusion to the phenomenon of wages. In a later chapter we shall con¬ 
cern ourselves primarily with the theory of wages. 


303 


304 


THE EXPANSION OF ECONOMIC CONCEPTS 


Labor Defined. —If one did little more than summarize critically the 
different interpretations of labor’s part in production, as they have appeared 
in nineteenth century economic philosophy, one would secure a fair appre¬ 
ciation of the history of the science of economics. A few of the major theses, 
such as the labor theory of value, the effect on wages of labor-saving devices, 
the history of the labor movement, division of labor, etc., are sufficient to 
indicate the part played by the concept of labor in economic analysis. With 
all the importance attached to labor, however, in treatises on economics, 
very few authorities have taken the trouble to define labor. 

Before the time of F. A. Walker, it is difficult to find any clear state¬ 
ment of labor’s distinctive position in economic theory. Even Walker does 
not take the trouble to define labor, but in his distinction between wages and 
the entrepreneur’s return (in his treatment of profits) Walker attempts to 
draw a sharp line between the wage earner and the entrepreneur while at the 
same time calling attention to the distinction between the entrepreneur and 
capitalist. In treatises on economics written in English there existed a vexing 
confusion of concepts with regard to each of these factors of production. 
Walker has the credit of effectively demonstrating that the confusion of 
concepts existed. When we come to study Walker’s distinction between 
profits and wages, as well as his distinction between profits and interest, we 
shall find that he very forcefully shows that the distinctions are imperative 
to an accurate approach to the problems involved. In several respects the 
interpretations made by Walker have had to be corrected by later authori¬ 
ties. Walker’s treatment of the subject, however, can be read with much 
profit. 

Fifty years earlier the distinction made by F. A. Walker had been made 
in France, for J. B. Say had made the distinction between the laborer and 
the entrepreneur even before the time of Ricardo. In calling attention to the 
failure of English authorities to recognize the distinction made by Say, Gide 
and Rist have the following to say: 

"Say’s very simple scheme of distribution constitutes a real progress. In the first place, 
it is much more exact than the Physiocrats, who conceived of exchange as taking place be¬ 
tween classes only, and not between individuals. It also enables us to distinguish the remun¬ 
eration of the capitalist from the earnngs of the entrepreneur, which were confounded by 
Adam Smith. The Scotch economist assumed that the entrepreneur was very frequently a 
capitalist, and confused the two functions, designating his total remuneration by the single 
word 'profit,’ without ever distinguishing between net interest of capital and profit properly 
so called. This regrettable confusion was followed by other English authors, and remained in 
English economic theory for a long time. Finally, Say’s theory has another advantage. It gave 
to his French successors a clear scheme of distribution which was wanting in Smith’s work, 
just at the time when Ricardo was attempting to overcome the omission by outlining a new 
theory of distribution. According to Ricardo, rent, by its very nature and the laws which 
give rise to it, is opposed to other revenues, and the rate of wages and profits must be regarded 
as direct opposites, so that the one can only increase if the other diminishes—an attractive but 
erroneous theory, and one which led to endless discussion among English economists, with the 
result that they abandoned it altogether. Say, by showing this dependence, which becomes 
quite clear if we regard wages and profits from the point of view of demand for commodities. 


LABOR IN THE PRODUCTIVE PROCESS 


305 


and by his demonstration that rent is determined by the same general causes— viz., demand and 
supply—as determine the exchange value of other productive services, saved political economy 
in France from a similar disaster. It was he, also, who furnished Walras with the first outlines 
of his attractive conception of prices and economic equilibrium. This explains why he never 
attached to the theory of rent the supreme importance given to it by English economists. In 
this respect he has been followed by the majority of French economists. On the other hand, 
and for a similar reason, he never went to the opposite extreme of denying the existence of 
rent altogether by regarding it merely as the revenue yielded by capital sunk in land. In this 
way he avoided the error which Carey and Bastiat attempted to defend at a later period.” 
(Hist, of Economic Doctrines, p. 114 .) 

The above quotation is so replete with information concerning the com¬ 
parative condition of economic philosophy with regard to the nature of the 
factors of production that we could not resist the temptation to quote it at 
length. We see from it that before we can proceed intelligently with the 
problem of defining labor it is necessary to make a summary of the history of 
the concepts of productive classes. 

The Physiocrats considered only one class productive, and did almost 
nothing in the direction of distinguishing the factors or agents of produc¬ 
tion. Their concept of the net product showed a vague glimmer of rent. But 
it was not thus understood. How and why that was associated with the 
agricultural classes was more nearly a theory of wages than it was one of 
rent. A similar line of reasoning led them to conclude that the artisans were 
sterile. That is to say that their theory of the sterility of the artisans amounted 
again to a theory of wages. The attributing of the net product to the landed 
proprietors and their defense of the proprietors’ right to the net product is 
highly illogical. All of this serves only to show how exceedingly confused the 
whole matter was in the mind of the early French economists. 

The early English classical economists showed a better apprehension of 
the phenomena under observation. With them there were three factors of 
production. These were land, labor and capital. With each of these was 
associated an elaborate analysis, not so much with regard to the factors 
themselves as with their shares in distribution. Yet in attempting to formu¬ 
late the law which controlled these shares in distribution it became neces¬ 
sary in one way or another to declare themselves as regards the characteristics 
of each of the factors. It is in these declarations that we find their concepts 
of each of the factors of production, and, of course that of labor. Their 
interest, however, centered in the income to labor instead of labor as such. 

In Neo-classical economics—now that we have bridged the gap between 
J. B. Say and F. A. Walker—we can say without fear of serious contradiction 
that economists are agreed that there are essentially four factors of produc¬ 
tion. Stated simply they are land, labor, capital, and enterprise (entrepre¬ 
neur) . They may be somewhat better presented, however, by not being 
considered of equal rank. Instead of enumerating them in succession they 
can be more accurately represented as two primary factors and one secondary 
factor. The primary factors are nature and man, while the secondary factor 


306 


THE EXPANSION OF ECONOMIC CONCEPTS 


is that of capital. Some such scheme as the following would seem to place 
them in their proper relationship to one another: 


1. Primary factors 


nature 


j land 

{ other natural agents 


( labor 
( enterprise 


2 . 


Secondary factor—capital 


capital goods 
capital values 


We have already attempted to explain the part played by nature in pro¬ 
duction. To follow an accurate parallelism it might have been better to head 
the present chapter "Man’s Part in Production”. Second thought, however, 
shows that such a heading as that would be misleading, since even capital 
and land are sterile unless vitalized by the hand of man. In our analysis, 
therefore, we have chosen to follow the device of recognizing that there are 
four factors of production of approximate equality in rank. 

With this plan of approach we are now ready to look for a satisfactory 
conception of labor. So long as men work at the direction of another they 
are laborers. It does not matter whether their tasks are menial or highly 
dignified; the fact that another will directs their productive activity makes 
them laborers. The term labor, therefore, is a very inclusive term. It extends 
all the way from the one who does the most menial task to the one whose 
task is dignified and highly paid—from the hod-carrier to the president of 
the corporation. 

Any other definition of labor than that would lead us into difficulties. 
Here, as in connection with natural agents, the function is frequently com¬ 
mingled with that of other agents. Yet under the modern system of industry 
we encounter very little difficulty in finding illustrations of persons who are 
laborers and nothing else. Frequently, however, laborers are at the same time 
capitalists and also entrepreneurs. In this chapter we are concerned pri¬ 
marily with the labor function, as distinct from the others even though at 
times we shall have to admit that laborers are not always exclusively laborers. 

The Division of Labor. —From the beginning of the science of eco¬ 
nomics some attention has been given to the concept of the division of 
labor. Even though the concept of labor itself was not clear, yet the virtues 
of the division of labor have been praised certainly ever since the time of 
Adam Smith. Smith’s famous illlustration is worthy of quotation in every 
treatise on the theory of labor. It follows: 


LABOR IN THE PRODUCTIVE PROCESS 


307 


“The effects of the division of labor, in the general business of society, will be more 
easily understood by considering in what manner it operates in some particular manufactures. 
. . . A workman not educated to this business [that of making pins] (which the division of 
labour has rendered a distinct trade), nor acquainted with the use of machinery employed in 
it (to the invention of which the same division of labour has probably given occasion), could 
scarce, perhaps, with utmost industry, make one pin a day, and certainly could not make 
twenty. But in the way in which this business is now carried on, not only the whole work 
is a peculiar trade, but it is divided into a number of branches, of which the greater part are 
likewise ptculiar trades. One man draws out the wire, another straightens it, a third cuts it, a 
fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires 
two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is 
another; it is even a trade by itself to put them into the paper; and the important business 
of making a pin is, in this manner, divided into about eighteen distinct operations, which, in 
some manufactories, are all performed by distinct hands, though in others the same man will 
sometimes perform two or three of them. I have seen a small manufactory of this kind where 
ten men only were employed, and some of them consequently performed two or three distinct 
operations. But though they were very poor, and therefore but indifferently accommodated 
with the necessary machinery, they could, when they exerted themselves, make among them 
about twelve pounds of pins a day.” (Wealth of Nations, Book I, Chapterl.) 

The description of the division of labor thus presented leaves much 
unsaid. The fact is that in Smith’s analysis only one of the several aspects of 
the division of labor appears. In our explanation of the division of labor 
concept in connection with Smith’s doctrine of spontaneity, however, we 
saw that he was at least aware of the several aspects of the same phenome¬ 
non. 

The virtues of the simpler forms of division of labor are easily pre¬ 
sented and comprehended. When, however, one undertakes to present its 
more illusive aspects one may encounter many complexities. This leads us 
to consider, at least in a cursory manner, the matter as a whole. 

(1) Subdivision of Tasks and Specialization .—Clearly men have apti¬ 
tudes that better adapt them to some tasks than others. The discovery of 
these aptitudes and the fitting of men to the tasks that they can best per¬ 
form have come to be a major concern of personnel agencies of modern 
industry. 

Presumably a man is worth more to the plant if he performs his task 
more speedily and efficiently than anyone else. Likewise no one questions 
the fact that it is better both for the plant and for society for ten men 
together to produce among them twelve pounds of pins a day than for each 
of them working separately to make one pin each. 

Of course, the average of a little more than a pound of pins a day for 
each man pales into insignificance before the output under modern systems 
of production. The blind zeal of the early classical economists for increasing 
the output per man, and thus increasing the wealth of the nation, has 
attained a scope far beyond their wildest dream. We have found that giving 
attention to productive efficiency is not enough. The multiplication of output 
has forced economists to give attention to certain accompanying attributes, 
not the least significant of which are (a) the effect of specialization on the 


308 


THE EXPANSION OF ECONOMIC CONCEPTS 


individual worker, and (b) the social justification of the introduction of 
labor-saving devices, and (c) the problems of adapting the increased pro¬ 
duction to the demand for the goods. The first two of these will receive 
consideration in another connection. The last point relates to the subjects 
of market value, normal value and the growth of population, as well as to 
some extent the subject of business crises. These subjects have already been 
under consideration in our study. 

(2) Occupational Division of Labor. —Subdivision of tasks within the 
plant are first and last matters of discipline. Enterprises may fail because of 
inefficient attention to this aspect of internal economies. But the phenomena 
relating to division of labor become much more impressive when attention 
is centered on occupational division of labor. Why, for instance, are some 
persons farmers and others shoemakers? Why are some enagaged in manufac¬ 
turing and others engaged in transportation? Answers to questions like these 
have led to some of the most interesting of any phenomena considered by 
economists. An exhaustive treatment of the whole question will be given 
in connection with our analysis of profits. 

(3) Territorial Division of Labor. (Localization of Labor.)—We have 
spoken of the phenomena relating to the occupational division of labor as 
being impressive. Those which relate to the territorial division of labor are 
more than impressive. There is a profundity in connection with them that 
few thinkers have been able to fathom. The phenomenon presents two aspects, 
viz., that of domestic trade and exchange, and that of international trade 
and exchange. It has been widely asserted that the same economic laws 
control domestic trade as control international trade. To a certain extent that 
assertion is not to be questioned. In other respects the statement is open to 
criticism. As is the case with previously mentioned aspects of the economic 
phenomena relating to the division of labor the expansion of economic con¬ 
cepts here can better be handled in another connection—especially under the 
heading of domestic and foreign exchange. 

From the above we see that anything like a comprehensive treatment of 
the subject of division of labor carries us into many fields of study. We have 
only mentioned them here with the hope that the reader will have his imagi¬ 
nation sufficiently aroused to follow us as we wade into those deeper prob¬ 
lems in a later study. 

The Laws of Labor. (1) The Laivs of Labor Distinguished f rom the 
Laws of Wages. —In treatises on economic theory we seldom find a clear dis¬ 
tinction drawn between the economic laws of labor and those controlling 
wages. That the distinction should be made is easily demonstrable, even 
though an accurate understanding of the phenomenon of wages is frequently 


LABOR IN THE PRODUCTIVE PROCESS 


309 


dependent upon that relating to labor. The laws which control wages relate 
to the share in distribution which goes to laborers as distinguished from the 
capitalists, land owners and others, whereas the laws of labor bear on the 
human exertion in production. 

(2) The Laws Analysed .—The two outstanding laws of labor are: 
(a) there can be no production without labor, and (b) the irksomeness of 
labor varies directly with constraint and inversely with freedom. 

With regard to the first of these the writer once heard a prominent 
socialist state categorically that there can be no value without labor. Shortly 
afterwards the occasion presented itself to request the socialist to explain 
further what he meant by his statement. After some hesitation he admitted 
that what he meant to say was that there could be no production without 
labor. He had thereupon turned an erroneous statement into a statement of a 
fundamental truth. 

We have already explained that every productive act tends to reduce 
rather than increase value. That is of necessity the case since value is the 
result of scarcity and every act of production is aimed at making goods 
more abundant, and therefore less valuable. It is clearly evident, therefore, 
that there can be value without labor—in fact we are almost ready to say 
that the less work that is done the more valuable goods become. The first law 
of labor, therefore, is that man must work to live. 

It is not always easily seen, however, that nature never produces alone. 

"We seldom, indeed, realize what a great part labour plays even in the making of prod¬ 
ucts which are often inaccurately termed 'natural.’ We are inclined to think, for example, 
that everything that grows in the earth—corn, vegetables, fruit—is a free gift of the earth, 
alma parens rerum. In reality, most of the plants used for man’s food have been, if not cre¬ 
ated, at least so modified by the cultivation and labour of hundreds of generations, that, to 
this day, botanists have not been able to discover their original types. Wheat, maize, lentils, 
beans, are nowhere to be found in their natural state. And the plants which we do find 
growing wild are singularly different from their cultivated brethren. The difference between 
our bunches of grapes and the acid berries of the wild vine; between the juicy vegetables and 
fruits of our gardens and the leathery roots and bitter, sometimes poisonous, berries of the 
wild varieties, is so great that we may look on our fruit and vegetables as artificial and as 
veritable creations of human industry. And the proof of this is that, if unremitting labour 
of cultivation be relaxed for a few years, these products immediately degenerate, that is to 
say, they return to their natural state and lose all the virtues which human industry has given 
them.” (Gide’s Principles of Political Economy, p. 8 5.) 

Nor can an exception be made of wild fruits that are fit for consump¬ 
tion in their wild state, nor yet the mineral water that runs out of the ground 
spontaneously—all such things are useless without the application of some 
effort in their acquisition. 

It becomes apparent, therefore, that the reason why it may seem at 
times that nature produces without the help of man is that equal amounts 
of labor seldom yield equal returns. Sometimes a very small exertion of effort 
will yield an handsome income, while at other times a very great amount of 


310 


THE EXPANSION OF ECONOMIC CONCEPTS 


work will net a very small return. Contemplation of that fact has led no less 
an authority than J. S. Mill to say: 

"If, therefore, the choice were to be made between communism with all its chances and 
the present state of society with all its sufferings and injustices; if the institution of private 
property necessarily carried with it as a consequence that the produce of labour should be 
apportioned as we now see it, almost in an inverse ratio to the labour—the largest portions to 
those who have never worked at all, the next largest to those whose work is almost nominal, 
and so in a descending scale, the remuneration dwindling as the work grows harder and more 
disagreeable, until the most fatiguing and exhausting bodily labour cannot count with cer¬ 
tainty on being able to earn even the necessaries of life; if this or communism were the alter¬ 
native, all the difficulties great or small, of communism, would be but as dust in the balance.” 
( Principles . Book II, Chapter 1, Section 3.) 

It must have been some such thought as that entertained by J. S. Mill 
which prompted our socialist friend to say that there can be no value without 
labor. The fact that equal amounts of labor (and we may, for simplicity, 
assume equal efficiency) do not secure equal returns is explained by the fact 
that nature assists man differently at different points. An easy way to see 
that fact is to consider the possibility of securing gold from the sea-water. 
It has been calculated that the amount of gold in the sea-water is enough to 
provide every man in the world with a sizeable fortune. Why does he not 
get the gold from the sea? The answer comes at once that we can work at 
something else and secure more gold than we could secure by the same 
amount of labor devoted to refining gold from the sea-water. We have here 
another illustration of the operation of the law of diminishing returns. 

The fact that nature assists man differently at different points becomes 
a matter of great importance in the selection of the kind of work to do. 
If, as stated by Mill, the product of labor is "apportioned in an inverse 
ratio to the amount of labour” performed, it would seem that man would 
consider carefully where, in the vast reservoir of nature’s resources he would 
apply his effort. The smallness of one’s income is as certainly due to man’s 
own shortsightedness in this particular as it is to the social order in which 
he happens to live. The ambition to secure a living with the smallest amount 
of work is not an unholy ambition so long as the returns are traceable to 
productive effort instead of exploitation. The fact is that society rewards 
handsomely the man that uses good judgment in production. This fact, to the 
writer, marks the greatness of the order under which we live—that of 
economic freedom. We at least have the right to make our own choice. 
Under other social orders that right can hardly be said to exist. All of this 
brings us to the discussion of the second great law of labor. 

Work v. Play .—Apparently somewhat contradictory to the second law of 
labor is the distinction between work and play. It is evident that the distinc¬ 
tion here is not to be found in the activity itself. Two persons might be— 
in fact, in many instances are—engaged in exactly similar activities and the 
one may be at work while the other is at play. Illustrations are too numer- 



LABOR IN THE PRODUCTIVE PROCESS 


311 


ous to mention. Each of two persons may be rowing boats; one may be 
doing it merely for the fun of it, and the other may be engaged at the task 
as his regular occupation. Similarly so for climbing mountains. In fact almost 
any activity may be in and of itself either work or play, depending on the 
ends sought. 

We have in this latter statement the real distinction between work and 
play. It is to be found in the end sought. If one engages in an activity for 
the sake of the activity itself one is playing, whereas if one expects compen¬ 
sation from the activity other than that found in the activity itself one is 
at work. Usually the compensation will take the form of money, but it may 
be many other things than money. Social acclaim may induce the courage¬ 
ous individual to risk his life in an effort. The mere gratitude that comes 
from the assistance* given a friend, in fact even nothing more than the 
satisfaction than one may feel, may be the only reward. So long as the 
activity is engaged in to some other end than merely that of the activitv 
itself, it is work. When the enjoyment is found in the activity itself it is 
play. 

Is it possible to abolish work ?—The second law of labor calls for an 
interesting bit of speculation. We make bold to say that no one will ques¬ 
tion the truthfulness of the principle in the statement that the irksomeness 
of labor varies direcly with contraint and inversely with freedom. There 
may be some difficulty in proving its exact mathematical accuracy. Mathe¬ 
matical accuracy, however, is not necessary. Certainly no labor is more pain¬ 
ful than that of the galley slave. The reason is that there constraint is at its 
maximum. Certainly no labor is more delightful than that of the artist 
engaged in the creation of a masterpiece. Would anyone question the fact 
that the irksomeness of the labor of the artist is at its minimum? The reason, 
of course, is that here constraint is at its minimum. The accuracy of the 
principle involved in the statement of the law makes us wonder whether 
or not it is possible to turn all work into play. 

The answer to this question is found in the fact that constraint may 
be at zero, and thus irksomeness likewise at zero, and yet the activity be 
that of work instead of play. The fact that the artist visualizes a reward 
in the satisfaction of having created what he (and possibly he alone) may 
consider his masterpiece reduces the activity involved in putting his inspira¬ 
tion on the canvas to work instead of play. The problem of reducing con¬ 
straint to its minimum—in fact, even the abolition of it—would not make 
play of any work at all, but it would make work as attractive as it is pos¬ 
sible to be made. It would bring a full realization of the benefits of the 
division of labor. 

The above comments do honor to the name of Charles Fourier, the 
French socialist. He long dreamed of working out a plan of reorganization 


312 


THE EXPANSION OF ECONOMIC CONCEPTS 


of society so as to remove all constraint from labor. His thesis was based on 
a further assumption that there is a Divine correlation between the different 
jobs to be done and the human inclinations to do the work. He thought 
that if society should be reorganized according to a plan set forth in his 
Nouveau Monde Industriel, by means of which all constraint was to be 
abolished, there would be enough persons with inclinations to do the different 
tasks that need to be done for all the work to be done without the need of 
constraint anywhere in the social order. We shall have to leave the reader to 
a further study of Fourier’s own writings if he desires to understand the social 
order as projected by Fourier. We can certainly follow Fourier to the extent 
of saying that anything that can be done in the direction of adapting per¬ 
sons to the tasks to which they are most inclined is of aid in making life 
more attractive, and possibly wealth more abundant. It is hardly too much 
to say that the objectives of all educational effort is, in one way or another, 
just that. Consciously to take a hand in the matter and once and for all 

abolish all constraint, and thus bring about a Divine correlation between 

human inclination and productive activities will possibly forever remain an 
utopian dream. Yet how beautiful is the dream! How wonderful would it 
be if every undertaking could be carried out with the enthusiasm of an 
artist working on his masterpiece! 

Historical Changes in the Status of Labor. —The fall of every 
great nation has been marked by a rise in the status of the working men. It 

is a well-known fact that the civilization of antiquity rested on slavery. A 

very interesting chapter in the economic history of mankind relates to the 
characteristics of slavery among the ancients. We need have no regrets that 
civilized man, at least in his aspirations, has risen above any toleration of 
slavery. 

(1) Emergence from Slavery .—After the fall of Rome came feudalism. 
With it came improved conditions of the working men. To understand 
clearly that fact it will be necessary to center our attention on some matters 
that do not bear directly on labor as such. 

The people who lived on the feudal estates fell roughly into two classes 
—the noble and the ignoble. In the sense in which we employ the term labor 
the laborers belonged only to the ignoble class. 

"The serfs were the descendants, or at least the successors, of the ancient Roman slaves. 
But in the course of centuries their condition had gradually become better. The master was 
also a landlord: he saw in the slave only an instrument of cultivation, and asked of him only 
that he make his domain bring in what it should. The rural slaves having ceased to be sold, 
could marry; and they remained fixed upon the same domain, founding there a race of culti¬ 
vators. Each family received from the master a house and a portion of land, which it trans¬ 
mitted from generation to generation and which the master gave up taking back. The serf had 
become a tenant. By the simple fact that slaves had been reduced to the role of cultivators and 
the master no longer demanded personal service from them, slavery had been transformed into 
serfdom.” (Charles Siegnobos: The Feudal Regime, pp. 9-10.) 


LABOR IN THE PRODUCTIVE PROCESS 


313 


Somewhat more dignified than the serf was the free villain. To quote 
again from Seignobos: 

The free men, in distinction from the serfs, owed nothing to the master; they were 
dependent upon him only in so far as he was their landlord, only because they lived upon his 
lands. They were renters or farmers in perpetuity. Their holding was a fragment of the great 
domain. They cultivated it for their profit, on the condition of paying either a fixed amount, 
like our farm-rents, or a certain part of the produce, as in our farming on shares. In distinc¬ 
tion from the renter or farmer of our day their condition was fixed forever; the landlord could 
not take back their lands nor increase their rent. On the condition that they paid the old 
charges they were free to dispose of their holdings, to bequeath it as they would, to transfer it, 
even (at least in France) to parcel it out.” {Ibid., p. 13.) 

Landless men were outlaws and stood at the mercy of any lord, villain, 
or serf. After the cities developed these men could find refuge there, but 
only with difficulty could they gain any sort of a respectable social status. 

Exactly how and why the town developed on the feudal estates we are 
unable to say. Possibly the best explanation is that they were the sources of 
certain kinds of supplies that could not readily be produced on the manor. 
But our discussion of the labor situation under feudalism would be insuffi¬ 
cient without some mention of the organization of the life in the towns. The 
free and landless villain must have been the nucleus around which there 
developed the movement which has taken form as the labor movement of 
our time. This had its inception in the towns. At first, however, town life 
was as rigidly and unalterably held in bonds as was the life in the country. 
The town productive organizations took the form of guilds—especially the 
craft guilds. 

"Usually full membership in the guilds was reached as a matter of course by the artisans 
passing through successive grades of apprentice, journeyman, and master. As an apprentice he 
was bound to a master for a number of years, living in his house and learning the trade in his 
shop. There was usually a signed contract entered into between the master and the parents of 
the apprentice, by which the former agreed to provide all necessary clothing, food, and lodg¬ 
ing, and teach to the apprentice all he himself knew about the craft. The latter, on the other 
hand, was bound to keep secret his master’s affairs, to obey all his commandments, and to 
behave himself properly in all things. After the expiration of the time agreed upon for his 
apprenticeship, which varied much in individual cases, but was apt to be about seven years, he 
became free of the trade as a journeyman, a full workman. The word journeyman may refer 
to the engagement being made by the day, from the French word journee, or to the habit of 
making journeys from town to town in search of work, or it may be derived from some other 
origin. As a journeyman he served for wages in the employ of his master. In many cases he 
saved enough money for the small requirements of setting up an independent shop.” (Cheney: 
Industrial History of England, pp. 65-66.) 

Since it is estimated that not less than four-fifths of the population lived 
in the country, the predominating types of laborers were the villains and 
serfs. They really paid the lords for the privilege of being allowed to work. 
In no sense, therefore, could it be said that anything like labor problems, as 
we know them, existed. But in the later years, particularly in England, 
there were peasant revolts, and after the black death the peasants slowly 
developed into more dignified ranks. 

In the towns, as we have seen, the journeymen received money wages. 


314 


THE EXPANSION OF ECONOMIC CONCEPTS 


But we should err if we looked upon them as we look upon laborers of today. 
Every one of them fully expected to become a master craftsman, and own 
his business. 

Under feudalism, therefore, we see a social order in which the people 
on the average lived better and were more generally contented than they 
ever had been before. At the top, however, civilization had been scaled down 
far below what it was in Roman times. 

The recurrence of slavery after the disintegration of feudalism in connec¬ 
tion with the African slave trade is another story, as are the present-day 
survivals in backward countries. This need not detain us here. 

(2) Emergence from Feudalism .—Before the industrial revolution there 
were essentially three characteristics of labor which are not true today. 

(a) Employers’ and employees’ interests were fused. The productive 
process being simple, the laborer could look forward to learning the trade at 
which he worked. At the expiration of the period of apprenticeship he became 
a journeyman, and then a master. The regulations of the crafts were so rigid 
that the artisans could not set up in competition with his master. There was 
not the sharp dividing line between the employer and the employee which we 
know today and to which we have given the term wage-system. 

(b) Productive processes were integrated. Before the industrial revolu¬ 
tion the worker was an artisan. Skill, training, and individuality were essen¬ 
tial to successful productive effort. Now laborers are faced with hundreds 
of jobs any one of which they may almost as readily accept as another if 
given a few weeks’ training. Quantity production instead of quality of the 
product is all too frequently the cry. The daily wage, with little visible con¬ 
nection between amount of work done and value received, is predominantly 
the method of compensation. Remoteness of the employer from the employee 
with little hope held out to the employee of ever becoming an owner of the 
business pervades our system. The workers, therefore, tend to think of their 
pay as being doled out to them. They, therefore, form unions and resort to 
collective action to assure a better share of the product. The labor union was, 
as we know it, inconceivable before the industrial revolution. It is hardly 
conceivable that our present social order could survive without it. 

(c) The existence of freedom of choice of occupation. Before the indus¬ 
trial revolution workers were bound to their jobs. This was true not only on 
the great feudal estates but was almost equally as true in the towns. To 
obtain work a man had to belong to a guild and he had to work accord¬ 
ing to terms and standards set by the guilds. 

The transition to the manufacturing system and the substitution of 
quantity production for quality production has broken these bonds. A regula¬ 
tion by a group of workers today forbidding other groups to engage in an 


LABOR IN THE PRODUCTIVE PROCESS 


3D 


occupation supposed to be preempted would be declared by the courts to be 
against public policy and hence voided. If an employer attempts to force 
a worker to perform a certain task he makes himself liable to penalty. The 
most that can be done safely by even labor unions is to penalize the members 
for doing things not belonging to that particular class of labor at which 
they may for the time be employed. The union may attempt to repress the 
increase in numbers of workmen fitted to do a given sort of work by for¬ 
bidding its members to give instruction to prospects. But commercial agen¬ 
cies are always available to give the instruction. Today laborers are masters 
of their own destiny and no social or political bonds can prevent them from 
rising to any heights that their abilities may allow. Such an economic order 
has probably never existed before in the history of the world. 

(3) Contract Labor .—The order under which we live is as much a 
juridical one as it is economic. Were it not for the fact that we can go into 
the courts and have our rights protected the order of economic freedom 
would cease to exist. Courts are not always impartial and farsighted in their 
decisions. Parties to the controversies are not always equal in strength. These 
facts, however, are no condemnation of the order. They are condemnations 
only because of the fact that the ideals of the order are not always realized. 

Critical analysis of wage contracts are not within the scope of this study. 
We should call attention to the fact that contract labor simply means the 
right which laborers have by terminable agreement to when, where, and how 
they will work in return for a plan of compensation understood in advance. 
When the compensation takes the form of money in return for a definite 
period of time it is called a wage. The payment in money for the time 
worked is known as the wage system. With it are associated many of the 
complexities of the modern economic order. 

Labor Gradations. —Thus far in our study we have employed the term 
laborer as if it applied to a conglomerate group of persons all of whom were 
engaged in tasks set by someone else. All too frequently the term has been 
used as if it applied only to those who do the menial tasks—especially those 
done with the hands. In fact, in the early history of the science of economics 
the term laborer meant practically nothing else but that which we mean 
today when we speak of hired men. When, however, we dignify the term 
hired men so as to include the so-called white-collared employees, it im¬ 
mediately becomes apparent that we must consider more carefully the matter 
of labor groups. When we do that we are forced to the recognition of some 
plan of gradation. That is but another way of saying that a full appreciation 
of the phenomena which relate to labor cannot be gained without the recog¬ 
nition of some kind of economic classes. It is important, however that we 
understand clearly just what is meant by our concept of economic classes. 


316 


THE EXPANSION OF ECONOMIC CONCEPTS 


(1) Caste Distingushed from Class .—Economists are likely to be con¬ 
sidered undemocratic unless they draw a clear line of distinction between the 
concept of the social caste and the economic class. When we recall, however, 
that a social caste occupies in law what has come to mean a legal status —a 
social ranking which the individual is himself powerless to break out of—it 
immediately becomes apparent that the term social caste means an entirely 
different thing from that of economic class. The caste is a matter of birth, 
whereas the economic class is a matter of choice—at least of attainment. 

It may be true that, even in a democratic society, children all too fre¬ 
quently tend to follow in the footsteps of their parents. The fact that they 
do, however, is not because of any legal bond that forces them to do so. 
In fact, the economist bases his main hope for any successful plan of social 
uplift upon the faith that more and more individuals will break through 
economic restrictions which surround them in the economic class to which 
they belong. To make it possible great educational institutions, in increasing 
numbers, are taking the youths of the land and allowing them to survey the 
horizon of economic opportunities with the view of helping them to find a 
footing in the highest economic class possible for them to attain. The econ¬ 
omist considers it not only one’s right but even one’s duty to make the 
most attractive living for one’s self and family that is possible with the 
resources at one’s command. To the extent that any kind of social cleavage, 
whether caste, race, or whatever it may be, stands in the way of the realiza¬ 
tion of that ideal, it is entirely vicious and should be suppressed. 

Yet the fact of the existence of economic classes in any society, however 
democratic it may be, is indisputable. Any economic analysis which does not 
recognize that fact can hardly present an accurate description of labor’s 
part in the productive process. 

(2) Gradations Amplified. —The theory of labor gradations seems to 
have had its origin in the famous mid-nineteenth century controversy over 
the wages-fund doctrine. That doctrine will come up for study later in our 
study. A fair sample of the language which marked the beginning of the 
recognition of labor gradations is the following: 

‘'The notion that all the labourers of a country constituting a body of general labourers 
capable of competing with each other, and whose ‘general’ or ‘average’ wage depends upon the 
ratio between their number and the aggregate wage-fund, is just as absurd as the notion of all 
different goods existing in a country at any given time—for example, the ships, and steam 
engines, and the cloth, etc.—constituting the stock of general commodities, the general or 
average price of which is determined by the supposed ratio between the supposed quantity of 
the whole aggregate stock and the total purchase-fund of the community. . . . How could the 
shoe-makers compete with the tailors, or the blacksmiths with the glass blowers? Or how 
should the capital which a master-shoe-maker saved by reducing the wages of his journey¬ 
men, get into the hands of the master tailor.” (Longe’s Refutation of the Wages Fund Theory, 
pp. 55-56.) 


LABOR IN THE PRODUCTIVE PROCESS 


317 


This attack by Longe came in for a good bit of dialetics on the part of 
J. E. Cairnes, in his Leading Principles of Political Economy , in which 
Cairnes undertook a defense of the wages-fund doctrine even after it had 
been abandoned by its great defender, J. S. Mill. Some fairly good observa¬ 
tions are made by Cairnes in his effort to show that in spite of labor grada¬ 
tions there is at all times an average wage and that a change of wages in 
one group might be expected to result in changes in other groups. Along 
with these feeble efforts of Cairnes to defend the wage-fund doctrine we 
find a recognition of the fact of labor gradations. From that time economic 
literature has been forced to correlate any theory of wages that may be 
advanced with the acceptance of labor gradations. 

Exactly how to represent the phenomenon of labor gradations is a prob¬ 
lem of no small significance. The presentation made by Professor Fetter is 
certainly a graphic one: 

"This doctrine may be represented schematically by a pyramid. [See Fig. 9.] A young 
man of certain ability and under certain conditions may be able to fit himself for any of sev¬ 
eral occupations, a, b, or c in class III. After he has mastered any trade (say Ilia) he may be 
able to advance (to class II), but in most cases he would find it each year increasingly difficult 
to do so. It is, however, easier to change on the same plane than to move upward, and it is 
usually still easier to go downward than to change on the same plane. In extreme cases the 
value of the labour of any non-competing classes is fixed as if each class occupied a separate 
island, and could not change occupations, but could only exchange products at the ratio re¬ 
sulting from the reciprocal bidding of traders. The masses of workers in any two countries of 
different resources and density of population, such, for example, as the United States and Italy 
or China, are to a certain degree in non-competing classes. If immigration is unrestricted by 
law, all that keeps wages from becoming identical for like classes of workers (as carpenters, 
painters, etc.) in the two countries is the difficulty of migration.” (Principles of Economics, 

pp. 120-21.) 

It would be an interesting study to see how nearly Professor Fetter’s dia¬ 
gram conforms to actual life—in other words, to draw a diagram that will 


I /Rare Ability 


JJ Specialists 

• 

i 

i 

i 

1 

i 

Id Shilled a | 

i 

i 

b \ C Trades 

2P Unskilled ) 

TorKmy Class 


FIGURE 9 

Reproduced from Fetter’s Principles of Economics, p. 221. 
Courtesy of The Century Company 
















318 


THE EXPANSION OF ECONOMIC CONCEPTS 


conform exactly to scale based on a statistical classification of laborers. We 
know, even without statistical proof, that the general thesis is correct. 

Probably a more accurate presentation of the subject is found in the 
following quotation: 

"A classification more suited to our existing conditions is offered by Giddings ( Political 
Science Quarterly, Vol. II, pp. 69-71). It is open to the objection that it draws broad lines of 
division where nature has made no broad lines; but it is perhaps as good as any division of 
industry into four grades can be. His divisions are (i) automatic manual labour, including 
common labourers and machine tenders; (ii) responsible manual labour, including those who 
can be entrusted with some responsibility and labour of self-direction; (iii) automatic brain 
workers, such as bookkeepers, and (iv) responsible brain workers, including the superintendents 
and directors.” (Marshall’s Principles of Economics, p. 218, footnote.) 

The economic welfare of any particular laborer bears so decidedly upon 
which of the grades of labor that he happens to fall in that it is hardly too 
much to say that the choice of one’s work is the most important decision 
in any man’s career. 

(3) Labor’s Cost of Production. —We said when we were considering 
nature’s part in production that the comprehension of that phenomenon was 
materially simplified by the fact that a natural agent has no cost of pro¬ 
duction. In spite of the fact that the problem of the natural agent was thus 
materially simplified yet it has taken many years to arrive at anything like 
a satisfactory explanation of nature’s part in production. We should not be 
surprised therefore when we find a slower approximation to the truth as to 
the more difficult phenomenon of labor. 

The fact that labor has a cost of production is easily apparent since it 
is expensive to rear children. When we say, therefore, that labor’s cost of pro¬ 
duction is measured by the cost of rearing children we state in very simple 
language a proposition that has many pitfalls. It happens that the pitfalls 
have frequently been mistaken for truths. We shall examine a few of them. 

(1) Assumption of a Uniform Cost of Rearing Children. —This pitfall 
has taken two forms: (a) each parent is most likely to consider his own 
cost as a typical cost, whereas hardly any two could have experienced the 
same cost. A similar thing is true of the cost of labor that is true of other 
things which have costs of production—we must somehow decide which of 
many costs to reckon with. The term cost of production, therefore, means 
so much that unless further analysed it is well night meaningless, (b) Early 
economists thought of means of subsistence as applicable to labor, disregard¬ 
ing labor gradations. They thus assumed an automatic adjustment of the 
supply of labor to the means of subsistence without a clear comprehension 
of either. This treatment of the subject made its appearance in Adam Smith’s 
Wealth of Nations when he assumed a spontaneous increase and decrease in 
population in response to the demand for labor. It came to full fruition in 


LABOR IN THE PRODUCTIVE PROCESS 


319 


the Malthusian theory of population when he said: "A man who is born into 
a world already possessed, if he cannot get subsistence from his parents on 
whom he has a just demand, and if the society does not want his labour, has 
no claim of right to the smallest portion of food, and in fact, has no business 
to be where he is. At nature’s mighty feast there is no vacant cover for him. 
She tells him to be gone.” The general import of the Malthusian thesis we 
have already explained. Ricardo so worked the same idea into his economic 
philosophy as to give the laborers a status almost if not quite as helpless 
and hopeless as it is under a caste system. 

(2) A similar line of reasoning, to no small extent based on classical 
economics, led socialists to the conclusion that if the established order offered 
no more hope than that the way out was to overthrow the established order. 
This we offer as the second pitfall. 

With the advent of marginalism and the development of the concept of 
gradations of labor it has become possible to present the cost of production of 
labor in a fashion that is neither unintelligible nor hopeless. True it is that 
no two families experience the same costs in rearing children. Yet for families 
in a certain class the costs do not vary between very wide points. After 
once the breadwinner of the family knows how much to count on as a 
dependable income he can hardly help being forced to count the costs of 
rearing a family. Some families, of course, may be childless, and others may 
be exceptionally large. But the family will on the average be large or small 
depending on the social standards of the class of labor to which the bread¬ 
winner belongs. We may say, therefore, that there is a marginal family for 
each class of labor in which family the cost of rearing children may be 
taken as the cost of labor for that group. If the standards are low, the costs 
are low and families are large; whereas if the standards are high the costs are 
high and the families not large. 

Why the position of the laborer is no longer a hopeless one is not so 
easily demonstrated. For the individual who desires and is able to rise out of 
his group, enlightened societies are not only extending a helping hand 
through free and compulsory educational agencies, but they are increasingly 
exerting positive efforts to discover neglected talents. Human ability should 
least of all sorts of wealth, be neglected. It cannot, like mineral deposits, 
endure while the prospector delays. 

The lifting of the exceptional individuals from the lower strata is help¬ 
ful, for it at least makes the income somewhat larger for the fewer who 
remain. But the great problem of social uplift is that of raising the standards- 
of living of the members of the lowest grade. That something has been 
done in that direction goes without saying. The advent of the order of 
economic freedom was the first and most essential step in that direction.. 
With it has come the centering of attention on labor problems. The recog-. 


320 


THE EXPANSION OF ECONOMIC CONCEPTS 


nition by society that these problems exist and even halting efforts to find 
solutions to them are at least hopeful signs. 

Labor Problems. —The development of the order of economic freedom 
was marked by a loosening of the ties which had so successfully bound to¬ 
gether the agents of production in previous eras. Persons were forced as best 
they could to find their own footing in the new industrial system. Under 
the previous arrangements each person’s career was fairly well marked out 
for him. Under the new order the elders are practically as helpless as their 
children in the face of the uncertainties present in the dynamic system in 
which they seek their income. The competitive order does not heal its own 
wounds. The great sponsor of that order—Adam Smith—thought that it 
would heal its own wounds. It has, therefore, taken many years and much 
effort to drive home the truth that the self-healing process cannot be 
relied on to provide solutions to what has come to be known as labor prob¬ 
lems. As a result we have them awaiting the attention of the social reformers. 

Only brief attention can here be given to each of these great problems. 
We hope, however, to be able to put them in their correct philosophical 
setting. 

(1) Unemployment .—In authoritative treatises on labor problems the 
problem of unemployment invariably heads the list. Persons who are able and 
willing to work but are unable to find work are considered unemployed. 
The mere fact that a person is out of a job is not enough. He may be unwill¬ 
ing to work at all; or he may be so choice in the type of work that he will 
do as to prefer to go hungry rather than "stoop” to the menial task; or he 
may be unable to work on account of old age or disability—such persons as 
these are not correctly considered among the unemployed. They must be able 
to work and be willing to work and unable to secure remunerative employ¬ 
ment to be considered among the unemployed. 

The fact, however, that almost any one can and in the last resort will 
do the menial tasks rather than go hungry concentrates the problem of 
unemployment in the lower grades of labor. The comparatively short period 
of time needed to harden one’s muscles so that one can make a fairly good 
^'hand” serves to draw into the class of unskilled many persons who may for 
some reason have lost their grips in any of the upper grades. The fact that 
it is much easier to fall than it is to rise is as certainly as true in the labor 
world as it is in the physical world. It is largely because of that fact that 
the problem of unemployment tends to be concentrated in the lowest grades 
of labor. It happens, therefore, that effective treatment of the unemployment 
problem in the lowest grades is effective for other grades as well. That must 
be so, since the elevation of the bottom layer of necessity raises all layers. 


LABOR IN THE PRODUCTIVE PROCESS 


321 


The unemployment problem assumes two major aspects; viz., seasonal and 
cyclical. 

Seasonal unemployment is perennial and can be fairly accurately gauged 
from one year to another. Many enterprises simply have to have more men 
at work at some times than at other times. When the men are wanted they 
count on being able to "pick them up” at their gates. Usually they are able 
to do that. The employer takes little if any responsibility for the men that 
he hires, other than that of the wage that he has to pay to get them to work. 
All too frequently society has done very little either for them or for the 
business men who need their services. The result is that of the problem of 
seasonal unemployment. The concomitants of this are the many "hangers 
on” around the business centers—casual laborers—who eke out a living by 
picking up jobs when they can. These men are easy prey to the unscrupu¬ 
lous employment agencies, and assemblages of casual laborers are seed-beds 
of revolutionary propaganda. The problem is at the same time so jeopardiz¬ 
ing to the established order and so comparatively simple in solution that we 
can only wonder at the limited amount of social attention which it has 
received. 

Stated briefly, the remedies are effective public labor exchanges and 
unemployment insurance. The first of these has already been considered in 
another connection. (See page 147.) 

Efficient labor exchanges should bring about as nearly a perfect adjust¬ 
ment of the supply of labor to the demand as it is possible to do. Through 
the instrumentality of exchanges the dovetailing process can be utilized to 
reduce unemployment to its absolute minimum. If it is found, as is widely 
assumed, that there is a total demand for more labor at some seasons than 
at others there should be some plan worked out for caring for the "labor 
reserve.” The most effective remedy seems to be that of unemployment 
insurance. If there are men whose services are actually needed at times during 
the year but whose services are not needed throughout the whole year, they 
deserve at least a minimum of competence during the intervals of unem¬ 
ployment. The competitive order supplies automatically no agency to provide 
that competence. Social insurance offers an effective and practical remedy. 
The technical aspects of unemployment insurance are readily available in 
works on labor problems and need not detain us here. 

Cyclical unemployment, associated as it is with business crises, affords 
all the enigmas of that economic phenomenon. To say, however, that human 
agencies are incapable of grappling with it in a constructive way is to admit 
defeat. The extent of unemployment that accompanies each great crisis forces 
us to admit, however, that the solution is as yet not at hand. Just as stu¬ 
dents of labor problems offer remedies for seasonal unemployment, they also 
stand ready with helpful suggestions for cyclical unemployment. 


322 


THE EXPANSION OF ECONOMIC CONCEPTS 


In the first place, to the extent that agencies which have been created to 
correct seasonal unemployment are available they should be utilized. Labor 
exchanges are indispensable. During the time of business depression, however, 
the exchanges will naturally be swamped with applicants for work. To the 
limited extent that jobs are available the exchange can immediately put the 
information in the hands of laborers who are adapted to the jobs at hand. 
At least the workers who secure the limited number of jobs will do so with 
the minimum of trouble and expense. In addition the records of labor 
exchanges will provide reliable information with regard to the extent of 
unemployment. In all probability newspaper reports of the extent of unem¬ 
ployment are highly colored and somewhat exaggerated. Through efficiently- 
handled labor exchanges the real truth can be known and widely circulated 
errors corrected. 

Unemployment insurance, although beneficial to a limited extent, can 
hardly be relied upon to provide anything like a satisfactory solution to 
cyclical unemployment. This fact is traceable fo two major influences: In 
many instances the business failures which accompany business crises—par¬ 
ticularly bank failures—carry down with them the funds which have been 
accumulated for the purpose of making possible unemployment benefits. 
To the extent, therefore, that the actuarial calculations may have made 
allowance for business crises, these allowances are of little avail if the invest¬ 
ments in which the funds are placed have lost their value. Besides unemploy¬ 
ment experiences on which the contributions for unemployment insurance 
have been based are more than likely merely seasonal in nature. Hence, even 
when the reserves can be kept intact it is very much to be doubted that they 
will be found large enough to meet the demands in times of crises. Unless the 
government comes to the rescue the strain may be too great, and a most 
excellent remedy for seasonal unemployment may be discredited. Cyclical 
unemployment, therefore, demands a more vigorous treatment than that of 
unemployment insurance. Since the result is almost bound to be a resort to 
charity, to the extent that charity must be applied it is certainly far better 
to have the regularly organized agencies for charity administer to the needy 
than it is to jeopardize the agencies which can well care for seasonal unem¬ 
ployment. 

But it is not charity that the men want. They want above all else an 
opportunity to earn the money with which to purchase their livelihood. 

Well-timed public works is the remedy which has had wide acclaim. 
The theory here is that the government should so plan its public works that 
they can be tied in with industry so as to be accelerated when private indus¬ 
try is slack and be slackened when private industry picks up. Ideally it 
would seem to be possible to create almost a perfect balance between public 
works and private industry so as to provide work for the unemployed in times 


LABOR IN THE PRODUCTIVE PROCESS 


323 


of depression. To make it effective, however, a great deal more attention 
will need to be given to the technical aspects of the proposition than has 
thus far been given. Then, too, the amount of public work that adapts itself 
to the coordination is itself quite limited. 

We can only conclude that cyclical unemployment is not exclusively a 
problem of unemployment. It is a problem of industry as a whole. Employers 
are just as certainly at the mercy of business crises as are the employees. The 
problem here, therefore, is nothing more than that of the business crisis. 
Strictly speaking, the problem of unemployment is limited to that of seasonal 
unemployment. Effective treatment of business crises will unavoidably mean 
effective treatment of cyclical unemployment. Until that treatment can be 
found it is hard to see that even seasonal unemployment can be satisfactorily 
handled. 

(2) Wages .—The problem of wages, of course, unless studied against the 
background of economic theory of wages can hardly receive competent treat¬ 
ment. Any social plan of treatment of the problem of wages in disregard 
of the economic laws which control wages is likely to hit wide of the mark. 
We are not at this point, however, interested in an analysis of the theory of 
wages, but instead we are here concerned with the problem of elevating the 
standard of living of wage-earners. Furthermore, since the most constructive 
social action in bettering the condition of labor is that done at the bottom 
the wage problem becomes essentially that of minimum-wage legislation. 

The suggestion of a minimum-wage law to the early economists would 
have been received with a benignant smile. Since the concept of labor grada¬ 
tions was not a part of their consciousness, and since they only vaguely 
understood the phenomenon of wages at all, the bearing of their philosophy 
on the consideration of minimum-wage laws need not detain us at this 
point. In his later years, however, J. S. Mill, who stood at the end of the early 
Classicals, assumed a much more tolerant attitude toward a conscious plan 
of treatment of the wage question. 

With the advent of the neo-classical economics there has come a slow 
but gradually increasingly tolerant attitude toward the feasibility of the 
establishment by law of a minimum wage. Only with excessive caution, 
however, do even the most advanced professional economists put their stamp 
of approval on minimum wage legislation. It can, nevertheless, be stated that 
modern economic philosophy recognizes it as an essential part of an up-to- 
date labor code. 

As is true with other aspects of labor problems we shall have to leave 
the reader to authoritative works on labor problems for the technical aspects 
of minimum-wage laws. It is sufficient to say here that no government 
should attempt minimum-wage legislation without first making a very 
careful study of the plan of operation in the particular locality where it is 


324 


THE EXPANSION OF ECONOMIC CONCEPTS 


to be applied. It is doubtful that it can ever be made applicable to all trades 
at once. A better plan seems to be to start with one or more of the poorest- 
paid occupations, and after it has become effective for them to extend the 
operation. In time it should be possible to bring it about that no full-time 
worker receives less than the established minimum. 

There will invariably be found many whose services are not worth the 
minimum established by law. If the truth were known it would probably be 
found that these unemployables are already being taken care of by someone. 
Why would it not be better once and for all for society to recognize the 
need of caring for the unemployables and remove them from competition 
with other workers whose wages they may be affecting adversely? 

(3) Child Labor .—To say that children should not be allowed to work 
under certain conditions would be almost as absurd as to say that there should 
be no restrictions placed on the rights of employers to hire children. When, 
therefore, we speak of the problem of child labor we have in mind to 
what extent children should be allowed to work rather than that they should 
beforbidden to work at all. 

There are at least three conditions under which children should not be 
allowed to do remunerative work at all. They are: 

(a) When they should be in school. 

(b) In the ''blind alley” trades. 

(c) Under surroundings which impair their moral and physical strength. 

With regard to the first of these, practically all civilized nations now 
have laws requiring compulsory attendance at school under certain ages. 
It therefore becomes illegal to employ children when they should be in school. 
Legislation of that kind has not been uniformly well enforced but it marks 
a great stride in the direction of industrial and social uplift. 

Blind-alley trades are those that offer little if any opportunity of better¬ 
ment—for instance, the ubiquitous "newsbutch” on our passenger trains. 
Whence do they come and whither do they go? They may grow up and die 
without ever having had a vision of better things. 

The great problem of child labor is that of keeping children out of the 
factories. The fact is that so much attention has lately been paid to that 
particular aspect of child labor that the very term child labor has come to 
be almost synonymous with it. The fundamental social problem involved in it 
is that society must conserve its youth for society itself to survive. The 
story of the long struggle for effective child-labor legislation belongs to a 
more exhaustive treatise on labor problems. It is not too much to say, however, 
that the absence of any effective prohibition of child labor from the textile 
mills and other factories is evidence of a selfish, narrow-minded, shortsighted 
and barbaric attitude toward a very important labor problem. 


LABOR IN THE PRODUCTIVE PROCESS 


325" 

(4) Hours of Labor. —Under modern industrialism seldom can a man 
decide for himself how many hours he will have to work during the day or 
how many days during the week. Under previous systems of production the 
length of the working day was not of so great significance. The work done 
was not so monotonous nor was it done under such calculated exactitude. If 
the workers under modern conditions of production had not found some relief 
in the reduction of the number of hours considered as a fair day’s labor we can 
only imagine what the consequences might have been. The victory for the 
eight-hour day is well-nigh complete. When exceptions become known the 
pressure of public opinion is so strong against the employer tolerating them 
as almost automatically to force a correction of the evil. 

How far the struggle for shorter work days and fewer days to the 
working week will go it is hard to say. It would seem, however, that in most 
types of work the eight-hour day is very nearly an ideal arrangement. The 
division of the twenty-four hours into three parts—eight hours to work, 
eight hours to sleep, and eight hours to do as one pleases—presents an attrac¬ 
tive arrangement. The half-day on Saturday, however, has long been some¬ 
thing of an anomoly. We should not be surprised if within a very near future 
the five-day week is as nearly universally recognized as is now the case with 
the eight-hour work day. 

The bearing of the introduction of labor-saving devices on the importance 
of reduction of hours belongs rather to the theory of wages. At this point, 
however, it may be noted that as a general proposition it has not been found 
that the reduction of hours has added to the cost of labor. Just as it is 
true that one can do on an average more work in eleven months than one 
can do in twelve, it is likewise true that as a rule men will turn out more 
work in eight hours than in ten. The psychological explanation of that phe¬ 
nomenon need not detain us here. The fact that they do, however, accounts 
for the fact that the adoption of an eight-hour work day has not materially 
increased the expenses of production. 

(6) Accidents, Sickness, Old Age and Death Benefits .—We have here 
included under one heading several different topics each of which, for 
exhaustive treatment, deserves much more extended comment than possible 
in this study. The reason why we are considering them jointly is the fact 
that effective treatment is found in some form of insurance. 

Workmen’s compensation legislation has come to be so well nigh uni¬ 
versally recognized as the proper treatment of the problem of industrial acci¬ 
dents that little if anything needs now to be said in justification of that plan 
of treatment. Injury to workmen has now come to be treated in the same 
manner as wear and tear on machinery—a cost which industry must bear. 
Employers, however, are, through workmen’s compensation laws given an 


326 


THE EXPANSION OF ECONOMIC CONCEPTS 


opportunity of protection against loss from that source, by insurance. In 
some instances the state creates and maintains an insurance association. When 
that is done insurance is provided at a minimum of expense. Usually, however, 
the availability of state insurance does not necessarily preclude insurance with 
other insurance companies in lieu of the state insurance. 

Indemnities which are paid for accidents under workmen’s compensation 
statutes are never very large. Yet the fact that they are well understood, 
certain, and easily collected makes that plan of compensation for accidents 
highly satisfactory. 

Enlightened employers whose enterprises are well established are now 
coming to recognize that their men should be protected from other hazards 
than those limited to the scope of the employment. The least expensive and 
a fairly satisfactory"' plan of coverage here is that of group insurance. The 
group policy is simply a term life policy which is renewable each year. It 
covers the whole established group of employees. In some cases the whole 
premium is paid by the employer. When that is the case little if any trouble 
need be encountered in securing a coverage for all of the employees. In other 
cases employees are required to pay a part of the premiums. When that is the 
case almost never is it possible to get them all unless made compulsory. 

Labor unions have found group insurance objectionable for two reasons. 
(1) It tends to tie the men to their jobs, and thus possibly hinders advance¬ 
ments into other positions which might pay better. That objection would 
vanish if all reputable employers carried group insurance. (2) In some 
instances employers have neglected to pay premiums when due, thus leading 
the men to expect compensation which was not available when needed. There 
seems little reason why a proper arrangement could not be made so as to 

*Note on Group Insurance .—'The fact that group life insurance offers little, if any, ad¬ 
vantage to the purchaser is evident because of two facts: (1) It is term insurance. Term 
insurance has at best only limited usefulness. When the term policy can be secured through 
the group plan it will usually afford a saving over the term policy purchased by the individual 
separately. If the group plan of writing insurance offered any real saving in the cost of insur¬ 
ance it would extend to other types of policies than that of the term. The small reduction in 
premium made to groups for other policies serves to defeat any assumption of superior economy 
of the group method of writing insurance. (2) It is likely to prove expensive. The only way 
that the individual can gain from the group policy is to die before the cash value of a policy 
of any other kind becomes large enough to neutralize the difference in. the cost. At the end of a 
twenty-year period, say, the cash value of a twenty-pay-life policy is something more than the 
total of the premiums actually paid. If that amount be added to the total paid for the group 
policy it will show a significant loss. That loss could, of course, be prevented by investing 
each year the amount saved by the group plan. Such thrift as that is rather more than to 
expect of the common individual. Yet even if he did invest the difference unless he died before 
the twenty years were up he would be worse off in that the insurance would expire and all 
that would remain would be the savings. 

Yet we must conclude that if an employer finds that the great percentage of his employees 
have no insurance at all he will most certainly do them a service by covering them by a group 
policy. This is true because it is better to have some insurance than none at all. Then, too, the 
opportunity to change over to some other form of insurance might be taken advantage of by 
many persons who may not have understood the proposition before. It is with these reservations 
that we endorse the group plan of insurance. 



LABOR IN THE PRODUCTIVE PROCESS 


327 


keep the men advised o i any lapse of duty on the part of the employer. 
It seems, therefore, that group insurance is a highly desirable plan of providing 
inexpensive compensation for sickness, accident, and death due to causes 
outside of the employment. 

Old-age benefits exist for the purpose of providing a modicum of income 
during the declining years. The problem here is somewhat different from 
other labor problems in that effort is made to assure an income to the workers 
after they have ceased to work. Employers have not been as loyal to their 
trust in this regard as they have in previous ones. It is true, however, that 
many industries do provide for the retirement of their employees upon an 
established income—usually something like half pay for the rest of their 
lives. To make a plan of retirement actuarially sound, has called for more 
careful study than has frequently been given the problem. As the urgency 
of the problem has become more clearly recognized increasing attention has 
been centered on making plans of retirement actuarially sound. Now the 
data are readily available, through the agency of insurance actuaries, so 
that there is little reason why plans for retirement allowances should not be 
instituted on bases which will enable the employees to be retired on an 
income which will at least keep them from poor houses. 

If the plans thus explained have been satisfactorily worked out, the field 
of life insurance has been somewhat narrowed. There seems little reason for 
any exercise of concerted social action to induce any particular individual to 
carry a life insurance policy however desirable that may be. The education in 
the general nature and desirability of insurance through the contacts with 
coverages already explained would seem to make the man with dependents 
an easy market for life insurance agents. We may well leave that to their own 
judgment and the salesmanship of private insurance companies. Death bene¬ 
fits, therefore, other than those allowed through social and group insurance 
would be expected to be secured from privately organized insurance agencies. 

We have been hearing a great deal today about abolishing poverty. If 
successful attention were given to each of the great measures provided in 
solutions to labor problems the ground for abolishing poverty would be so 
nearly covered that poverty could hardly any longer be cause of serious 
worry. 

The Rise of the Laborers to the Consciousness of their Own 
Strength. —The fact that under the competitive order the laborers are the 
masters of their own destiny has not failed to receive attention by the labor¬ 
ers themslves. In fact so well have they become conscious of their own 
strength that at times their leaders assume what appears to students of 
economics a short-sighted attitude toward social betterment. For instance, 
labor organizations generally oppose minimum-wage legislation, on the ground 


328 


THE EXPANSION OF ECONOMIC CONCEPTS 


that through collective bargaining they are able effectively to handle the 
wage contract. They have opposed efforts to establish public labor exchanges 
because one of their strongest ties is that of finding jobs for their members. 
If that function is absorbed by the public labor exchanges they fear that 
they will lose one of the strongest connections between the men and the 
unions. Group insurance, as well as old age benefits provided by the employ¬ 
ers, have come in for their condemnation. Their assertion here is that if 
their employers have anything to offer them in addition to their wages let 
them give it to them in the form of increased pay and they will take care 
of their own insurance and retirement benefits. 

In spite of the fact that in these and few other instances organized 
labor has taken what we think is a short-sighted attitude toward important 
labor problems, they have shown so much wisdom in other respects that the 
organized labor movement deserves much commendation for its determined 
resistence to the obstacles that forced its inception and growth. It can 
truly be thought of as the rise of the laborers to the consciousness of their 
own strength. 

There are several points of view from which to approach unionism. 
The most helpful are (1) the changing legal status of unionism, (2) the 
structural group, and (3) functional types. 

With regard to the first of these we have the bitter struggle of labor for 
the right to organize and the right to employ effective weapons of defense 
in their controversies with the employers. It is not too much to say that 
they have well-nigh completely and universally won the right to organize. 
Even yet, however, labor encounters many obstacles in the way of effective 
use of the weapons at their disposal. The right to strike, for instance, is 
hedged about by restrictions which make it a much less powerful weapon 
of defense than it may sometimes appear. Yet no one seriously questions today 
the right of the laborers to form themselves into unions. With that right 
established in law the way has been opened for the bringing to bear the 
pressure of the whole labor force in the direction of protecting the interest 
of laborers. 

With regard to structural groups we find methods of perfecting an 
organization that really serve as a mouth-piece of labor’s economic inter¬ 
ests. In each great industrial nation extensive use of the trial and error method 
has been made before anything like an effective central organ has been 
created. In England, for instance, affiliated crafts have succeeded in form¬ 
ing very strong unions, but the central coordinating agencies are weak. 
The result has been that a labor party has come into being to effectively 
stand for the labor interest in general. In the United States the crafts and 
trade unions have become well united and have succeeded in bringing into 
existence the American Federation of Labor. This organization works effec- 


LABOR IN THE PRODUCTIVE PROCESS 


}29 


tively and constructively for labor’s interest as a whole. Even though not 
all of the important trade unions belong to the American Federation of 
Labor, yet there is a very strong feeling of fellowship among them whether 
members of the Federation or not. Whether the central labor organization 
takes the form of a party as in England, or that of a big central organiza¬ 
tion as in the United States, there has come to exist evidence of vision and 
statesmanship among labor leaders that is a credit to them and proof of 
their wisdom. 

A third approach to unionism is that of functional types. This approach 
is made a great deal of by Robert F. Hoxie in his Trade Unionism in the 
United States. Here we have at least four subdivisions: (a) the business or 
bargaining union, (b) the uplift union, (c) the revolutionary union, and 
(d) the exploitative or predatory union. 

Generally the more conservative unions limit their activities to the first 
of these functions. Yet instances may be found of other objectives even 
among the most conservative organizations. We cannot say, therefore, that 
a classification of unionism according to functional types correlates with a 
classification according to any other method. In some communities the car¬ 
penter’s union might be merely a business union while in others it might 
be revolutionary or even exploitative. 

The business union works for better wage contract. The trade agree¬ 
ment is its agency of expression and it is usually satisfied with a contract 
which gets for its members what it considers a fair wage agreement. 

Uplift unionism is characterized by humanitarian efforts. Its main meth¬ 
ods are friendly benefits and mutual insurance. This was more a character¬ 
istic of early unions than it is now. The work of the Knight of Labor is an 
illustration. 

Revolutionary unions aim at the overthrow of the established order, 
particularly the wage system. Members of unions of this type are as a rule 
socialists of one type or another. There are many different plans of revolu- 
tionay social changes as there are many brands of socialism. 

In rare instances unions are exploitative. Exploitation may appear in either 
of two ways: that of holding up the employer or that of collusion with 
the employer. 

The exploitative or predatory union is mentioned last not because we 
feel that to be a major characteristic of unionism. The fact is that we 
doubt that the predatory type is of great significance. Generally, however, 
the employer who finds himself forced to reckon with the union in making 
decisions regarding wage policies concludes that the very nature of the 
union is predatory whereas in fact the men may be doing no more than 
standing for their just awards. Similarly so for the public. At times the 
insistent demands of unions for the rights of the laborers may create the 


330 


THE EXPANSION OF ECONOMIC CONCEPTS 


impression on the public that they are predatory when they are not correctly 
so considered. It would certainly be inaccurate, however, to assume that 
unions never become predatory. 

The rise of the laborers to the consciousness of their own strength brings 
with it a result which is most encouraging. Enlightened employers no longer 
assume laborers are a blind force to be dealt with like so many cattle. 
Through some plan of industrial cooperation the employers now take their 
men into their confidence. The men simply have to be dealt with as sensible 
human beings. Any other plan of dealing with them in the industries invari¬ 
ably brings trouble. In those industries where the employees are not dealt 
with as sensible human beings, capable of understanding their own problems, 
sooner or later trouble develops. Whenever employers have dealt with their 
employees as men capable of understanding their own problem in relation to 
the problems of the plant their response has almost invariably been such as 
to justify the faith which economists hold in the possibility of effective social 
uplift in the order of economic freedom. A full appreciation of that fact, 
however, cannot be had without a comprehension of the phenomena relating 
to capital. It is that with which we are next concerned. 


Karl Marx ( 1818 - 1883 ) 



At this point we are including in our hall of fame the portrait of a man whose economic 
philosophy, as we have stated a number of times, will not in any respect stand the test of 
careful analysis. When it is remembered that it is not always the accuracy of their economic 
analysis that makes writers on economic subjects worthy of attention no apology is necessary 
for placing the face of Karl Marx at the head of a chapter on capital. If a writer has success¬ 
fully opened up a subject in a challenging way, and has attracted the attention of many 
serious-minded students of the subject he is certainly worthy of attention even if that atten¬ 
tion is nothing more than that of refuting his arguments. 

To the mind of the writer very few of the authorities on economics have seen clearly 
in connection with the subject of capital anyway. Most of them have given attention to the 
phenomenon of interest even when treating capital. We are therefore holding up to view the 


331 






332 


THE EXPANSION OF ECONOMIC CONCEPTS 


•great socialist crusader even though we consider that his main contribution was merely that 
•of opening up in a challenging way a subject which was little understood by himself, and 
is hardly better understood by those whom we consider more profound students of the subject 
of economics. 

Following their practice of giving, in the footnotes, an excellent summary of the lives 
and contributions of the major figures in economics Gide and Rist give the following resume 
of Karl Marx: 

"Karl Marx, generally spoken of as a Jew, was born on May 5, 1818, of Jewish parents 
who had been converted to Protestantism. Born of a respectable bourgeois family and wedded 
to the daughter of a German baron, few would have predicted for him the career of a militant 
socialist. Such was to be his lot, however. In 1843, at the age of twenty-five, the authorities 
having suppressed a newspaper which he was conducting, he fled to Paris, and thence to Brus¬ 
sels. Returning to Germany during the Revolution of 1848, in which he took an active part, 
he was again expelled, and this time took refuge in London (1849). Here he spent the rest 
of his life (about thirty years), leaving for France a short time before his death in 1883. He 
died at London on March 14, in that year. 

"Although Marx was one of the founders and directors of the famous association known 
as the 'International’, which was the terror of every European Government between 1863 and 
1872, he was not a mere revolutionary like his rival Bakunin, nor was he a famous tribune of 
the people like Lassalle. He was essentially a student, an affectionate father, like Proudhon, 
an indefatigable traveler, and a man of great intellectual culture. 

"The best known of his works, which is frequently quoted but seldom read, is Das 
Kapital, of which the first volume—the only one published during his lifetime—appeared in 
1867. The other two volumes were issued after his death, in 188 5 and 1894, through the 
efforts of his collaborator, Engels. 

"This book has exercised a great influence upon the nineteenth century thought, and 
probably no work, with the exception of the Bible and the Pandects, has given rise to such a 
host of commentators and apologists. Marx’s other writings, though much less frequently 
quoted, are also exceedingly important, especially La Misere de la Philosophic, published in 
1847 in answer to Proudhon’s les Contradictions Economiques; Xur Kritik der politischen 
Oekonomie (1859); and particularly the Communist Manifesto, published in January, 1848. 
The Manifesto is merely a pamphlet, and at first it attracted scarcely any attention, but 
Labriola goes so far as to say—not without some exaggeration, perhaps—that 'the date of its 
publication marks the beginning of a new era’ ... At any rate, it is the breviary of modern 
socialism. There is scarcely a single one of its phrases, each of which stings like a dart, that 
has not been invoked a thousand times. The Programme of the Communist Manifesto is 
included in Ensor’s Modern Socialism. 

"It is a much debated question as to whether Karl Marx was influenced by French 
socialists, and to what extent. On the question of his indebtedness to Pecqueur and Proudhon 
see Bourguin’s article in La Revue d’ Economic politique, 1892, on Des Rapports entre Proud¬ 
hon et K. Marx. Proudhon’s work, at any rate, was known to him, for one of his books was 
a refutation of the doctrines of the petit bourgeois, as he called him. Certain analogies between 
the works of these two writers to which we shall have to call attention will help us to appre¬ 
ciate the extent to which Marx is indebted to Proudhon. But, as Anton Menger has pointed 
out, we must seek Marx’s antecedents among English socialists, in the works of writers like 
Thompson especially. Nor must we forget his friend and collaborator Friedrich Engels, who 
for the sake of his master has been content to remain in the background. Engels collaborated 
in the publication of the famous Manifesto in 1848, and it was he who piously collected and 
edited Karl Marx’s posthumous work. It is difficult to know exactly what part he played in 
the development of Marx’s ideas, but it is highly probable that it was considerable.” —History 
<of Economic Doctrines, pp. 449-50, note. 


CHAPTER IV. 


CAPITAL AS A FACTOR IN PRODUCTION 

The term capital is employed with many different shades of meaning. 
With the business men it is almost never employed in exactly the same sense 
as with the economist. The socialists probably use the term more frequently 
than anyone else. Yet very seldom does the socialist mean the same by it as 
does the economist. The real truth, however, seems to be that the economist 
in attempting to discover characteristics of the thing under consideration 
which he calls capital is thinking of it in its fundamental aspects. The use 
of the term as employed by other parties, whether business men or socialists, 
though on the face somewhat different from that of the economist almost 
always signifies that which is implied in the thing which the economists term 
capital. It becomes necessary, therefore, to make a number of distinctions 
before we can proceed with an examination of that which we have chosen 
to designate by the term capital. By doing that it should become possible to 
comprehend not only the thing in its pure aspects, but also to gain a more 
accurate view of the more casual use of the term. The concepts likely to 
be confused are: (1) capital values as distinguished from capital goods, and 
(2) lucrative capital as distinguished from productive capital (concrete 
capital goods). 

Capital Values v. Capital Goods. —Were it not for the befogging 
phenomenon of price we should define capital values as merely the price of 
capital goods. The fact that capital values are invariably expressed in terms 
of money makes it all the more important that we draw a clear line of 
demarcation between the value and the price of capital goods. Sufficient 
attention has already been given to the distinction between value and price. 
(See Chapter VI.) 

The distinction between capital values and capital goods becomes appar¬ 
ent in the balance sheet of a newly organized corporation somewhat as fol¬ 
lows: Let us assume that the corporation is capitalized at, say, $100,000, 
and that the whole of the cash is available for the purposes of the business. 
Before the enterprise is under way the statement would show: 

333 


334 


THE EXPANSION OF ECONOMIC CONCEPTS 


Assets Liabilities 

Cash.$100,000 Capital-stock . . $100,000 

Money being a capital good and as yet none of it having been invested 
in the project to be launched the whole of the assets remains as money, and 
is so represented in the statement. No business, however, can thrive by keep¬ 
ing all of its assets in money. As soon as practicable, therefore, the money 
should and will be exchanged for the plant and equipment. After that has 
been done the statement will reflect the transaction somewhat as follows: 

Assets Liabilities 

Itemization of the Capital stock . . $100,000 

plant and equipment-$ 95,000 
Cash. 5,000 


Total .... $100,000 

If we should follow the procedure from year to year we should note 
changes from time to time. These changes would show effects of wastage 
of assets and efforts to retain their values. The trained eye would see many 
of the items which cannot logically be called capital goods which would yet 
have capital values. We shall see shortly what these are. Some items would 
appear which have no costs in the economic sense. Although appearing in 
the "capital structure” of the business they cannot be considered logically 
as capital. The trained economist can, by reading between the lines, separate 
out those things which cannot be treated as capital in a scientific way, 
although he must recognize the necessity of treating them as capital values. 
We may say, therefore, for the sake of simplicity, that on the assets side of 
the balance sheet will be found the capital goods along with other items that 
cannot thus be considered, while on the liabilities side will be found the 
values. 

Lucrative v. Productive Capital. —The distinction between lucrative 
capital and productive capital is very similar to that already made between 
capital values and capital goods. There are, however, several shades of distinc¬ 
tion: (1) The existence of capital values does not of necessity assume the 
existence of tangible and transferable evidences of those values. Usually, of 
course, the values are transferable but they may not be so because of the fact 
that they are publicly owned or because of the fact of immobility. (2) Lucra¬ 
tive capital may at the same time be capital goods. Usually lucrative capital 
belongs to that class of goods known to law as choses in action. It is valu¬ 
able simply because of the fact that it represents a right to capital goods. 



CAPITAL AS FACTOR IN PRODUCTION 


33f 


The goods are employed in production and those who employ them pay for 
the privilege of using them. It is the payment for the use of the capital 
goods which accounts for the income to the owners of the pieces of paper 
which evidence the rights to capital values. (3) Lucrative capital also may 
exist without standing for any particular capital goods; in fact it may exist 
without standing for any capital goods at all. The lucrative capital will have 
value if the income is paid regularly whether or not the income is derived 
from any productive agency brought into being by the loan. As long as the 
income is continuous and certain the owner cares little from what source 
the income is derived. It is generally expected, however, that lucrative capital 
will represent rights to definite capital goods which are productive in nature 
and that the income will be continuous and certain because of the fact that 
it does stand for a right to income-bearing property. Needless to say, the 
source of the income could likewise be either rent, profits, or interest. Lucra¬ 
tive capital, therefore, is a much broader term than productive capital. 

From the above distinctions it becomes apparent that neither the busi¬ 
ness man nor the socialist employs the term capital in an entirely different 
sense from that of the economist, but rather as a modification of that use. 
Capital values exist because of the fact of capital goods, although in many 
instances capital values relate to things which cannot logically be called 
capital goods. Lucrative capital represents evidences of rights to incomes. 
These incomes are frequently tied in with capital values. It not infrequently 
happens however, that lucrative capita exists independently of the existence 
of capital goods. Capital values are not coterminous with capital goods nor 
is lucrative capital exactly coterminous with productive capital. When the 
business man employs the term capital he most frequently means capital 
values, while when the term is used by socialists most frequently lucrative 
capital is meant. In economics the terms capital and capital goods are well 
night interchangeable. Although some of the phenomena of capital can at 
times best be explained by centering on capital values, at other times they 
can best be understood by centering on lucrative capital. When these shifts 
in points of view are made, however, attention should be called to the fact of 
the shifts so as to avoid confusion in the mind of the reader. 

Capitalistic Production. (1) Indirectness v. Timeliness .—Capitalistic 
production is very frequently spoken of as indirect production. Direct pro¬ 
duction and capitalistic production are in fact frequently the exact opposites 
of each other. Yet a closer view reveals the fact that it is not indirectness 
that is the essential point. A roundabout way of doing anything is usually 
the most uneconomic way to do it. The resort to capitalistic production is 
well-nigh synonymous with economic efficiency. If one satisfies one’s thirst 
by sipping the water from one’s hand one is resorting to what is usually 


336 


THE EXPANSION OF ECONOMIC CONCEPTS 


thought of as direct production. The folding of a leaf from which to drink 
the water is illustrative of capitalistic production. The leaf for the time 
becomes a capital good which is destroyed with one use. 

To save the trouble of recurring trips to the spring an extension of capi¬ 
talistic production may take the form of a crude vessel made, say, from a 
hollow log, in which a whole day’s supply of water may be kept available 
at the primitive man’s cabin. In fact we may assume that the water might 
be diverted from the spring so that it flows readily and continuously by the 
cabin. Thus never again will the primitive man need to return for his daily 
supply of water. The time thus saved may be devoted to other pursuits so 
as to make his life somewhat more abundant. 

A further advance might find the incipient capitalist piping the water to 
other cabins and charging regularly for the service provided. Thereupon it is 
even conceivable that the need for further productive labor on the part of 
the owner of the water system would disappear. The income from the water 
"rentals” might reasonably be enough to support him. At the same time the 
contributors of the income could easily well afford to pay him for the right 
to use water from his lines. The time saved which otherwise would have to 
be devoted to the lugging of the water from the spring can now be devoted 
to other productive pursuits. We have in this simple illustration all of the 
ear-marks of capitalistic production. The question may well be asked whether 
it is indirectness or timeliness that is the genuine test of capitalistic pro¬ 
duction. 

The fact that capitalistic production is usually marked by indirectness is 
not enough to support the contention that indirect production is always 
synonymous with capitalistic production. The motive of resorting to capital¬ 
istic production is never that of roundaboutness. The fact that it of neces¬ 
sity has to be indirect is evidently not enough to lead us to conclude that 
indirectness is the test of capitalistic production. The motive is either that 
of enabling one to gain the same amount of satisfaction with less total 
effort, or that of gaining an increase in satisfaction with less than an 
equivalent increase in the total expenditure of effort. We are thus led to the 
conclusion that timeliness and not indirectness is the test of capitalistic 
production. 

(2) The Growth of Capitalistic Production .—Economists never tire of 
singing the praises of the virtues of capitalistic production. It is much easier 
to find a basis for its eulogy than it is to show clearly how it all actually 
came about. 

The illustration which we have just given may represent fairly well the 
nature of the income which is made possible by capitalistic production, yet 
it fails much of representing the well-nigh unsurmountable task of creating 
the first capital. We may glibly imagine the primitive man cutting out and 


CAPITAL AS FACTOR IN PRODUCTION 


337 


caulking up a hollow log for the purpose of carrying along a day’s supply 
of water. The act of cutting and caulking assumes the possession of tools. 
We can imagine the primitive man shaping crude implements with which 
to prepare the crude vessel. But it is a laborious task, as any civilized man 
will testify, if he is ever temporarily faced with a problem of that kind. 
How much more puzzling the problem must have become when the primitive 
man faced longingly the hope of working out a satisfactory plan of piping 
the water supply to the whole town. But is the problem fundamentally 
different from that of any modern man when he faces longingly easier and 
simpler means of accomplishing a desired end? 

The origin and growth of capitalistic production seems to find its expla¬ 
nation in man’s gradual discovery of methods of satisfying those longings. 
Once the immediate problem has been solved, thereafter easier and better 
methods can be discovered by employing implements and processes previously 
brought into use. Man, therefore, becomes so completely dependent on 
capitalistic production that he cannot live very long without it. 

Yet we live in the midst of a wondrous order made possible by the growth 
and maintenance of capital goods. The capitalistic order, however, is some¬ 
what disappointing when we consider its limitations: 

"But our exultation disappears if we consider how slight is the assistance rendered by 
machinery in satisfying the two fundamental needs of every human society—the need of food 
and the need of shelter. 

"It is calculated that in France less than 200,000 horse-power are employed in agriculture 
—not even 1 Zz °fo of the total. Is this slow development of the use of machinery in the pro¬ 
duction of food entirely due, as is often thought, to the conservative attitude of agricultural 
folk, or is it rather due to the very nature of agricultural production? This latter explanatior 
seems to us to be the true one. Land is life’s laboratory, and life has special laws of develop¬ 
ment which are peculiar to it. Moreover, most of the machines used in agriculture aim only at 
economizing hand labour or speeding it up, and not at increasing the quantity of produce.” 
(Gide: Principles, p. 79.) 

Mankind needs to turn his longing in the direction of producing a larger 
net return from each acre of land. Thus far capitalistic production has 
tended to reduce rather than increase the net yield per acre. 

The Economic Theory of Capital. (1) Mill’s Fundamental Princi¬ 
ples of Capital Analysed and Criticised. —Mill’s fundamental principles of 
capital are of peculiar interest to us because they furnish an excellent vantage 
point from which to view the economic concepts of capital as they appeared 
before his time as well as the amendments that have been made to those con¬ 
cepts by later writers. Stated briefly those concepts are: (a) industry is 
limited by capital, (b) capital is the result of saving, (c) all capital is con¬ 
sumed, and (d) capital supports labor. 

The first of the fundamental concepts as explained by Mill is a develop¬ 
ment from one presented by Adam Smith and marks little if any advance 
over that concept. Smith’s statement of the proposition was, "As the 


338 


THE EXPANSION OF ECONOMIC CONCEPTS 


accumulation of stock must, in the nature of things, be previous to the 
division of labour, so labour can be more and more subdivided in proportion 
only as stock is previously more and more accumulated” (Vol. I, Book II, 
(Introduction). Among Mill’s comments on the fact that industry is limited 
by capital we find the following startling statement: ''When industry has 
not come up to the limit imposed by capital, governments may, in various 
ways, for example by importing additional labourers, bring it nearer that 
limit: as by the importation of coolies and free negroes in to the West 
Indies.” (Book I, Chapter V, Sec. 2.) 

A more accurate apprehension of the relation of capital to labor reveals 
that it is the shortage of labor-saving devices (of capital goods) rather than 
its abundance that is conducive to the demand for more laborers. The truth, 
therefore, seems to be that industry is activated by capital rather than that it 
is limited by capital. 

The confusion in the mind of Mill of lucrative capital with concrete 
capital goods probably accounts for his comment. Capital goods—labor- 
saving devices—can never be the moving force for the introduction of more 
laborers. The more machinery we have the less labor we need. Hence if we 
use the word capital as synonymous with capital goods it is certainly not 
correct to say that industry is limited by capital. On the other hand if our 
point of view is shifted to that of lucrative capital—loanable funds—the 
relation of capital to industry assumes a different aspect. We cannot even 
then state that industry is limited by capital. We can say, however, that 
industry is activated by capital. That is to say the larger the supply of lucra¬ 
tive capital the lower the interest rate tends to fall. As the rate of interest 
falls the increased demand for capital goods tends to cause their prices to 
rise. It is the rise in prices of capital goods that opens the way for the 
employment of more laborers. The following famous and searching criticism 
of the point of view advanced by Smith and Mill is given to reinforce the 
conclusion of the author in this regard: 

"The whole of Adam Smith’s argument is most delusive. Division of labour, far from 
necessitating a greater provision of stock or capital, rather economizes it. The isolated man is 
not less, but more, in need of a stock of past labour than men who live in society. If a hundred 
men on board ship, instead of dividing their labour in the usual manner, all tried to turn their 
hand to everything, they would very soon be wrecked, but they would not require less but 
more stores than a crew of the same number who behaved more sensibly. If the same hundred 
men, when establishing themselves on the desert island on which we may suppose them to 
wreck the ship, proceeded to divide their labour, they certainly would not be any more in need 
of a stock than if they attempted to live in isolation. If, for example, 30 went to hunt, 20 to 
fish, 10 to gather sticks for fires, 10 to find water, and 30 to build huts, no greater accumu¬ 
lation would be required before they could devote themselves to these peculiar businesses than 
if each man hunted 3 hours, fished for 2, looked for water for 1, and built him a hut for 3 
hours. On the contrary, they would require a smaller stock of provisions, tools, and material.” 
(Cannan’s Theories of Production and Distribution, pp. 80-81.) 

“As usual, we must here trace Adam Smith’s error to his habit of reasoning too hastily 
from the individual to the community. Seeing that the capital of an employer should be greater, 
if he is to be successful, when the division of labour is far advanced and the processes of pro- 


CAPITAL AS FACTOR IN PRODUCTION 


339 


duction are more effective and elaborate, he promptly assumes that the community is subject 
to the same need; whereas, though the increase of capital and the increase of the division of 
labour may, as a matter of fact, advance together, the increase of capital is not the cause or 
indispensable preliminary of the increase of division of labour.” ( Ibid ., p. 83.) 

Since the publication of Cannan’s searching criticism of the concept 
advanced by Smith and accepted by Mill no later authority need fall into 
the error of assuming that industry is limited by capital. 

The second proposition advanced by Mill, that capital is the result of 
saving, is equally as vulnerable. No writer is more careful to call attention 
to the fact that capital must be distinguished from money than Mill. Yet 
the assumption that capital is the result of saving seems to have its basis in 
the confusion of money with capital. The act of saving money may have 
an important bearing on the existence of capital. Yet the act of saving and 
the act of creating capital are not necessarily correlative acts. 

The kernel of Mill’s thought appears in the following utterance: "To 
consume less than is produced is saving; and that is the process by which 
capital is increased; not necessarily by consuming less, absolutely. We must 
not allow ourselves to be so much the slave of words, as to be unable to 
use the word saving in this sense, without being in danger of forgetting 
that to increase capital there is another way besides consuming less, namely, 
produce more.” (Book I, Chapter V, Sec. 4.) 

The doctrine that capital is the result of saving has become so indelibly 
stamped on economic philosophy that it is not likely soon to be erased. Since 
the time of Adam Smith few if any reputable economists have so much as 
seriously questioned the fact that capital is the result of saving. The contro¬ 
versies which have developed have grown out of differences in opinion with 
regard to the explanation of the interest phenomenon. A summary of these 
controversies will be made in connection with our discussion of the subject of 
interest. The author feels, however, that a more critical examination of the 
general assumption that capital is the result of saving should be made. 

The fact is that logically capital cannot be the result merely of saving. 
When we come to consider interest, particularly the interest rate, we shall 
see a very definite bearing of the act of saving on the interest rate. But to 
say that capital is the result of saving is really begging the question. A 
thing has to exist before it can be saved. The creation of capital is therefore 
a positive act. Professor Gide comes to our rescue in this connection with the 
following language: 

"What is meant, then, by the statement that capital is created by saving? Simply this: 
that if wealth were consumed as soon as it was formed, capital would never exist. It is obvious, 
indeed, that if the poultry farmer left no eggs in the nest to be hatched, there would never be 
any chickens. Nevertheless, if a child asked you where chickens came from, and you told him 
that the only way to get chickens was to abstain from eating eggs, he would be right in 
regarding this answer as a piece of good advice, to be sure, but as a foolish explanation. 

(Principles of Political Economy, p. 112.) 


340 


THE EXPANSION OF ECONOMIC CONCEPTS 


Professor Gide follows with the comment that saving is the condition of 
the creation of capital. It is, however, not the explanation of the creation of 
capital. We can agree with Professor Gide that capital has to be conserved or 
society will lose the benefits of capitalistic production. Conservation of the 
supply of capital can hardly be considered as synonymous with saving. We 
shall give further attention to this point a little later in this chapter. 

The third of Mill’s fundamental propositions is more characteristically 
a Mill doctrine. In this connection the following statement made by Mill has 
been widely quoted: "An enemy lays waste a country by fire and sword, and 
destroys or carries away nearly all the moveable wealth existing in it; all 
the inhabitants are ruined, and yet, in a few years after, everything is 
much as it was before. This vis medicatrix naturae has been a subject of 
sterile astonishment, or has been cited to exemplify the wonderful strength 
of the principle of saving, which can repair such enormous losses in so brief 
an interval. There is nothing at all wonderful in the matter. What the enemy 
have destroyed would have been destroyed in a little time by the inhabitants 
themselves.” (Book I, Chap. V, Sec. 7.) 

While there is a very evident truth in Mill’s comment, there is at the 
same time a very evident fallacy. A critical examination of the nature of 
capital must reveal the distinction between capital values and capital goods. 
The word capital all too frequently is employed indiscriminately to refer 
either to capital values or to capital goods. It would seem that a better prac¬ 
tice would be to confine the term capital to capital values. It is true that 
capital goods are all the time being used up. Yet sound business practice 
always conserves the capital values. If that is not done, and capital values 
are allowed to dissipate, only with the greatest difficulty can the loss be 
made up. Sections of the world which have borne the consequences of destruc¬ 
tive wars bear a ghastly testimony to that fact. Only can it be said that the 
reduction of the value of capital is beneficial when that reduction is due to 
its increase. A fall in the value of capital due to its increase may be taken 
as a sign of affluence. But when the values are lost because the whole supply 
has been burned or torn away certainly an injury occurs which is hard to 
repair within a short period of time. 

Mill’s fourth proposition, namely, that capital supports labor, contains 
so much of truth mingled with so much of error, at the same time so much 
of significance in the expansion of economic concepts, that little of import¬ 
ance can be said about it at this point. In this proposition was found the 
acceptance of the famous wages-fund doctrine which after much searching 
of hearts had to be dropped from accepted economic analysis. Really, we find 
in connection with this proposition the whole of the question of the relation 
of interest to wages. That question will receive treatment in the handling of 
those subjects. 


CAPITAL AS FACTOR IN PRODUCTION 


341 


(2) Capital Must be Distinguished from Land and Other Natural Agents. 
—Before proceeding with our own examination of the nature of capital it 
remains for us to continue with the unpleasant task of clearing away points 
of view which seem to the author to confuse rather than clarify the subject 
under study. The failure to draw a clear line of distinction between capital 
and natural agents is particularly vicious in that it frequently results in plans 
of social control which are destined to do great harm. We shall do, therefore, 
all in our power once and for all to settle that controversy. 

One of the most discouraging aspects of economics is the frequent con¬ 
fusion of terms without genuine confusion of concepts. This fact can some¬ 
time accounts for the confusion of capital with natural agents. Not infre¬ 
quently, however, an author apparently over-ambitious to show his brilliance, 
will hit on some kind of a new departure in the use of terms and make that 
departure as if he is making a new contribution to the science of economics. 
More progress could certainly be made if serious efforts were exerted to make 
a less frequent departure from terms already in use. An illustration of the 
point here referred to appears to be in the following failure to distinguish 
capital from natural agents: 

“We can include all kinds of wealth under the term capital and still recognize the dis¬ 
tinction between different kinds of wealth by dividing capital into three classes named above. 
It is a good thing to do this because business men regard all kinds of wealth as capital, and 
there is much to be gained by using the term in a sense that is already familiar to the average 
reader. Therefore, we shall always use the term capital in this book in the broad sense in 
which it has been defined above, as referring to a stock of wealth.” (Bye: Principles of 
.Economics , p. 23, note.) 

Since the very essence of a science is exactitude, and since the popular use 
of no word is very exact nothing but confusion can result from the attempt 
to employ in a scientific way a word as it is popularly employed. Besides, as 
we have many times said in this study, to confuse wealth with value is one 
of the most misleading things that a person can do. To refer to capital as a 
stock of wealth can do little more than leave the reader perplexed with regard 
to the whole proposition. The conservative business man will be one of the 
first to admit his inability to account for the phenomena regarding capital. It 
is the duty of the economists to help the business men to see through the 
problems that are puzzling them. It is hard to see that we can do that very 
well unless we call attention to aspects of the problem which they have 
been unaware of. One of these aspects is that capital has properties peculiar 
to itself and that it must be thus treated when the problem is approached 
scientifically. 

It most frequently occurs that persons who confuse capital with land 
do so because of their inability to see that land has any characteristics differ¬ 
ent from capital. We have already alluded (p. 281) to the way that Professor 
Marshall handled the subject in his answer to a statement of the kind made 
by Professor Fetter. We do not feel that a more satisfactory answer to the 


342 


THE EXPANSION OF ECONOMIC CONCEPTS 


proposition here under consideration can be made. In most instances when 
capital is confused with land the confusion grows out of a line of thought 
similar to that presented by Professor Fetter. We feel that any further criti¬ 
cism than that offered by Professor Marshall is unnecessary. We do feel, how¬ 
ever, that a word should be said by way of seeking an explanation of the 
confusion. 

The simpest explanation and the one most easily understood is the fact 
that both natural agents and capital tend to be thought of in connection 
with their values rather than in relation to their fundamental attributes. 
The fact is that the value of capital goods and of natural agents is arrived 
at in precisely the same way. It is the capitalization of the net earning power 
of each. A natural agent which has a net earning power of, say, $1,000 a 
year is worth $20,000 if it is capitalized at 5%. A similar value will be shown 
for a capital good which has a net earning power of $1,000 a year. If we do 
not look deeper, therefore, and consider the fundamental attributes of the 
factors themselves we can easily allow ourselves to treat them as the same 
phenomenon. 

(3) Not Two Distinctions but at Least Six. —A critical view of the 
distinction between natural agents and capital reveals at least six distinct 
value situations. They are: (1) goods without a cost which are indestruc¬ 
tible, (2) goods without a cost which are destructible and irreplaceable, (3) 
goods without a cost which are destructible and replaceable, (4) goods with 
a cost which are indestructible, ( 5 ) goods with a cost which are destructible 
and irreplaceable, and (6) goods with a cost which are destructible and 
replaceable. Let us examine carefully each of these. Goods without a cost 
which are indestructible are not numerous. We have already seen that when 
treating this subject Professor Marshall was forced to draw on his imagina¬ 
tion for an illustration. We have, however, now a standing example in the 
radio-wave channel. The value of the right to broadcast has no relation 
whatever to the cost of production. Once we get that phenomenon fixed in 
our mind we can easily discover many other illustrations of the same phe¬ 
nomenon. That is, of course, the fundamental attribute of land and is the 
source of pure rent. In accounting practice the peculiar characteristic here 
appears in that no depreciation account is necessary to compensate for a loss 
in value. The value of a natural agent is therefore a capitalization of its net 
income independently of any depreciation charge. 

The good which has no cost of production but which is destructible is 
much more easily discovered. 

"For, except when mines, quarries, etc., are practically inexhaustible, the excess of their 
income over their direct outgoings has to be regarded, in part at least, as the price got by the 
sale of the stored-up goods—stored up by nature indeed, but now treated as private property; 
and, therefore, the marginal supply price of minerals includes a royalty in addition to the 
marginal expenses of working the mine. Of course, the owner desires to receive the royalty 


CAPITAL AS FACTOR IN PRODUCTION 


343 


without undue delay; and the contract between him and the lessee often provides, partly fo£ 
this reason, for the payment of a rent as well as a royalty. But the royalty itself on a ton of 
coal, when accurately adjusted, represents that diminution in the value of the mine, regarded 
as a source of wealth in the future, which is caused by taking the ton out of nature’s store¬ 
house.” (Marshall’s Principles of Economics, pp. 43 8-9.) 

It is readily seen that in accounting practice a wastage charge has to be 
jnade for goods of this kind lest the value be forever lost. The fact, however, 
that they came originally without a cost forces us logically to the conclusion 
that they must receive treatment based on their peculiarity as a gift of 
nature. The problem of calculating the value of a thing like this in contrast 
with the indestructible natural agent becomes apparent when we consider an 
assumption such as the following. Suppose that the net income is exactly 
$1,000 a year and the exact duration is twenty years. We immediately see 
that the capitalized value is a sum different from the $20,000, which we 
found as the possible value of the first illustration. 

Goods without a cost which are valuable and at the same time destruc¬ 
tible and replaceable are the easiest of all to find. A ready illustration is that 
of natural fertility of farm lands, as is also true of virgin forests. Wanton 
destruction of these natural resources is probably less culpable than that 
involved in the one just mentioned. It is, however, a shortsighted policy 
condemned in no uncertain terms by all thinking men. The value situation 
here, from the standpoint of accounting is not materially different from 
that of a coal mine. The depreciation account has to be set up so as to make 
sure that the fertility is kept at least as good as it was to start with. It is in 
connection with propositions like this that we discover the phenomenon of 
the investment of capital in land. After a time it will become very difficult 
to make a clear distinction between the reinvested liquid capital and the 
original fertility. In fact, however, if the investment has been accurately 
made the values remain as they were, merely a conserved gift of nature. 

The fourth class of goods is almost as illusive as the first. Goods which 
have a cost of production and which are indestructible may be hard to dis¬ 
cover in actual existence. Yet there are many which approximate that charac¬ 
teristic. The fact that their values may change though the material content 
may be indefinitely durable is a complicating circumstance which need not 
worry us here. The phenomenon of changing values of durable goods, whether 
natural agents or capital goods, calls for special treatment. But we can con¬ 
ceive of goods which are permanently durable which to begin with had 
to be produced. The most ready illustration is that of radium. The rate of 
destruction of radium is so slow that within the contemplation of any human 
utilization it is indestructible. Other illustrations may be readily brought to 
mind. We are told that a properly constructed sewer line buried deep in the 
ground is indestructible. Great engineering projects sometimes partake of 
that characteristic. If, however, we could think of these only in our imagina- 


344 


THE EXPANSION OF ECONOMIC CONCEPTS 


tion the illustration would serve our purpose. The longer the durability the 
more valuable the good would be, owing to the fact that a smaller amount 
would have to be deducted from the income for the upkeep. 

Goods which have a cost of production and which are destructible and 
not replaceable are easily thought of. The first edition of a famous book, the 
surviving works of dead artists, rare pieces of antique furniture are a few 
illustrations that come to mind. Fortunately for the business world most of 
the capital goods are capable of being replaced. It would certainly not be 
accurate to say that irreplaceable goods which have in the past had a cost of 
production are not the sources of income. Persons who own them may charge 
for the privilege of seeing them. Even when they are public property they 
may be the indirect source of attractive private gains. Tourists spend many 
millions of dollars each year in visiting art centers mainly to view their 
prize possessions. To say, therefore, that these things are not sources of 
incomes is contrary to fact. They are even capital goods. They are not used, 
however, in the definite production of other goods which are to be sold. The 
most that can be done is to copy them and sell cheap imitations. Persons pay 
for the privilege of seeing a great painting much as they do for a delicious 
meal. Fortunately they are not destroyed in one or two visitations. But they 
are not permanently durable, and to conserve them there must be the exer¬ 
cise of great care. 

Goods which have a cost of production and which are destructible and 
replaceable are seen all about us. The contrast between the value of a piece of 
antique furniture and that of one purchasable in the local store is evidence 
of the effect of replaceability on value. Practically all of the things employed 
in productive processes conform to this test. The changes which are due to 
engineering advance are not to be taken seriously in this connection. When¬ 
ever new pieces are not at hand exactly similar to those displaced usually 
others may be had to serve the purpose better. Up-to-date plants, therefore, 
can and do keep their equipment intact. They conserve the value of those 
things. They do it, of course, by setting aside a portion of the income large 
enough' to purchase other equipment whenever necessary. If, for instance, 
the income is $2,000 a year, and it takes exactly $1,000 to keep the plant 
operating in perfect efficiency, we have a net income of $1,000 a year. We 
have, therefore, value exactly the same as that of a natural agent which nets 
an income of $1,000 against which does not have to be charged depreciation. 

There is really a seventh value situation with regard to goods employed 
in productive processes. This last, however, cannot be separated from any 
of the others since it may at times apply to any of them. This relates to the 
change in value independently of the question of durability. In connection 
with natural agents their value may change either upward or downward 
because of shifting in human affairs. When the value of a natural agent 


CAPITAL AS FACTOR IN PRODUCTION 


345 


shifts upward—that is to say, when its earning power rises—the phenomenon 
is thought of as a dynamic rent. When it shifts the other way—that is to 
say, when its earning power falls—it is best thought of as a negative rent. 
In connection with natural agents, particularly land, the net result is almost 
certain to be upward. That is to say that the value of the whole supply of 
the land of a nation tends to rise from year to year in spite of the fact that 
here and there land values may be experiencing a decline in value. 

When the phenomenon of an increase in the earning power of a capital 
good makes its appearance, that is, when there occurs a sudden and unex¬ 
pected demand for goods which can be freely reproduced, they may encoun¬ 
ter a rise in value due to the fact that it will take time to get more of them 
into action. The longer it takes to bring them into existence the more lasting 
will be that increased value and the increase in income made possible by it. 
We have in that instance a phenomenon that for the time resembles rent. 
It is not rent, however, since it is only a question of time before it will 
vanish. The increased income has well been called quasi-rent. On the other 
side may occur a decline in value due to the fact that the machine has lost 
in favor before it is worn out. If the whole truth were known we should 
probably find that with regard to goods which have a cost of production 
their loss in value, from year to year, will exceed their gain. Recognizing that 
fact accountants have insisted that not only must a depreciation account be 
made up against capital goods but there must also be an obsolesence charge. 

Note on the Expression Cost of Production .—The sharp line of distinction made at this 
point in our study between goods with and goods without costs of production calls for some 
comment. This is especially so since there are a few economists who hold that every economic 
good must have at least a first cost. When we speak of the cost of production we are thinking 
of the recurring rather than the first cost. We feel that great mischief may result, however, 
from not drawing a clear line of distinction between goods with costs and goods without 
costs. 

Even if the assumption were accurate that no good exists without at least a first cost it 
would in no material way modify the lines of reason which we have developed. It is the limit 
approached rather than the actuality of the existence of valuable goods without cost that is 
of scientific significance. If we have two things of equal value, the one being of small cost 
while the other has been procured at great cost the difference in costs measures the value of 
nature’s part in the production of those goods. If the first had no cost whatever the problem 
would not be materially altered. Zero instead of a calculable amount would have to be de¬ 
ducted from the value in order to find a measure of nature’s part. The right to make the 
assumption that the limit has been reached is of as great a significance in explaining rent as 
if no assumption were necessary. We may say, therefore, that the acceptance or the rejection of 
the general proposition that all goods must have a first cost is of no material scientific significance. 
It may be necessary to draw on our imagination in order to find a clear illustration of a good 
with value which has no cost at all. The fact that we may be forced to do that in order to see 
more clearly certain phenomena of every day occurrence cannot be considered as doing 
violence to scientific analysis. Although goods of this kind are exceedingly rare we are not 
ready to say that they do not really exist. 

The confusion here, as is often true, grows out of the confusion of wealth with value. 
Every productive act creates utility and tends to reduce value. When the supply of an 
economic good cannot be modified by a productive act its value ceases to be influenced by 
cost of production. Its value is then determined by forces operating independently of cost 
of production. It has no normal value. During the interval of time, as sometimes happens, 
when the supply of a capital good cannot respond readily to cost influences it behaves very 


346 


THE EXPANSION OF ECONOMIC CONCEPTS 


much like a natural agent. Since, however, it will be merely a matter of time before new 
supplies of anything the supply of which is capable of being increased will flow into the 
channels of trade the abnormal value of capital becomes a temporary phenomenon. 

A natural agent, being by the very conditions of its existence incapable of duplication 
must of necessity have a value independent of any cost of production. The fact that some 
cost may have been incurred in the first instance in the discovery of its existence is entirely 
aside from the point. For a natural agent to have value as a natural agent it has to have a 
value in excess of any amount that may be necessary to cover any cost which may have been 
incurred in its discovery. Whether the cost was incurred or not is of no significance in the 
value of a natural agent. In its purest form it would exist without any cost, would have 
value, and would be permanently durable. The student can in his own mind build a value 
structure of natural agents which vary from the ideal. 

This practice is unquestionably good accounting as it is also good prac¬ 
tical economics. For our purposes here, however, we are forced to do a thing 
that is so often necessary to do in economic analysis. That is to assume that 
the complicating circumstance is absent for the purpose of gaining a better 
appreciation of the economic laws at work. Then when necessary we can 
make corrections for error when the principles discovered are being applied 
in actual practice. Each of the value situations, therefore, is more clearly 
understood if we assume the values which we may have discovered to be 
constant. 

If we approach the distinction between capital goods and natural agents 
in this way we can without serious difficulty discover the shades of distinc¬ 
tion between them. Capital goods belong to those which have costs of pro¬ 
duction while natural agents belong to those which do not have costs of 
production. Not all goods, however, which have costs of production are 
capital goods. Some are prized merely for the pleasure of possessing them. 
Even the gold hoard of the miser can hardly be spoken of as capital while 
thus held as merely a prize possession. Neither are all natural agents valu¬ 
able. Many natural agents have utility without having value. 

Those goods which have costs of production and which are employed in 
the furtherance of production are called capital goods. Natural agents, owing 
to the fact that they do not have costs of production, even though they 
may be employed in the furtherance of production cannot logically be called 
capital goods. The economic laws controlling the size of the incomes and 
hence the values of each of these operate differently. In connection with capi¬ 
tal goods we discover the phenomenon of interest and its concomitants. In 
connection with the natural agents we discover the phenomenon of rent 
and its concomitants. We shall see more about each of these shares in distri¬ 
bution in later chapters. 

(4) How Capital Is Formed .— (a) The saving thesis. Beginning with 
Adam Smith and extending to the present, orthodox economists have sought 
the explanation of the formation of capital in saving. Before examining more 
critically the merits of the proposition let us take a brief panoramic view 
of these theses. 


CAPITAL AS FACTOR IN PRODUCTION 


347 


(i) Adam Smith and the Spontaneity Thesis. —In connection with our 
examination of Smith’s doctrine of spontaneity we have already seen (Chap¬ 
ter III, Part I, p. 68) that Smith accounted for the origin and growth of 
capital by the fact that men are impelled to set aside a part of their incomes 
to the care of themselves and their families in the future. Even though the 
savings of any particular person may be small, yet it is added to the accumu¬ 
lations of many others, and like the honey in the bee hive, all the time 
the supply tends to be increased above that consumed. Thus automatically 
and spontaneously the supply of capital tends to be conserved and increased. 
Governmental interference is not only not necessary but is positively harm¬ 
ful. This is considered by Smith one of the many instances in which man’s 
tendency to follow his own self-interest involuntarily promotes the interest 
of society as a whole. 

(ii) Ricardo’s Concept of the Stationary State. —Extending Smith’s doc¬ 
trine, as in so many other aspects of economic theory, Ricardo attempted 
to follow the forces under his consideration to their logical conclusion. In 
connection with the cost of production of capital it led him to his famous 
concept of the stationary state. Loyal to the Malthusian doctrine of popula- 
tin, Ricardo could not imagine a possibility of an enduring rise in wages. 
He thought, therefore, that the struggle was between the capitalist and wage 
earners for any amount not absorbed by the land owners. The capitalist had 
to yield to the laborers any amount of an increase in income. That was true 
because by hypothesis wages could not fall. In time, however, all rises in 
prices would be absorbed by the land owners. In a growing society, there¬ 
for, rising rents meant declining profits. Since land had no cost of produc¬ 
tion there was no limit to the possible rise in the value of land. Capital does 
have a cost of production—that of the willingness of the capitalist to 
save, and hence the cost of production of capital establishes the limit of the 
potential rise in rent. When that limit is reached, society has arrived at the 
stationary state. The stationary state, however, is not the concept with 
which we are interested at this point but that of the cost of production of 
capital. 

It will be remembered that among the early economists the term "profits” 
was employed as a sort of composite of interest, profits, and entrepreneur’s 
gains. In the stationary-state illustration, however, it signifies the returns to 
the capitalists as a reward for saving. It becomes apparent, therefore, that 
Ricardo meant by capital the reserve of loanable funds—lucrative capital, 
and he thought of the cost of capital as the sacrifice made by the capitalist 
in the process of saving. If the reward fell so low that the inducement to 
save was not enough to restrain the impulse to consume, saving would be 


348 


THE EXPANSION OF ECONOMIC CONCEPTS 


checkmated and progress would stop. It was then that he thought the sta¬ 
tionary state would make its appearance. 

Ricardo, however, had a more searching theory of the source of capital. 
It appeared in his crystallized labor thesis. This grew out of his labor theory 
of value. It is accounted for by his effort to show that the amount of labor 
required to produce anything measured its value. The whole of the amount 
of labor required to produce anything, however, included capital—accumulated 
labor. The crystallized labor thesis, however, throws little if any light on the 
cost of production of capital. We are led, therefore, to conclude that when 
Ricardo thought of the cost of production of capital he thought primarily of 
lucrative capital. The concept is at best only vaguely apprehended—as is 
true of so many of the early economic concepts having their foundation 
really in the writings of Adam Smith and being more fully developed by 
Ricardo. 

(iii) /. S. Mill and the Savings Thesis. —We have already examined Mill’s 
acceptance of the savings doctrine in connection with the four fundamental 
propositions regarding capital. It can hardly be said that Mill made any 
advance at all over the concepts as advanced by Ricardo. He even glorified 
the stationary state, as one in which man might seek the outlet for his 
activities in pursuit of art and culture. 

(iv) The Neo-classical Thesis. —Though much work has been done in 
the field of capital and interest since the time of Mill, we can find little if any 
justification in an assumption that the neo-classical economists have in any 
material respects departed from the general thesis that capital is the result 
of saving. Most of the neo-classical concern has been with a satisfactory 
explanation of the interest rate. In this connection neo-classical economics 
shows a marked advance over that of its predecessors. When we come to 
study interest independently it will be our pleasure to summarize these 
theories. 

(b) The Challenge io the Savings Thesis. —Very soon after the appear¬ 
ance of Adam Smith’s great work several brilliant writers challenged the 
accuracy of his treatment of the bearing of self-interest on the accumula¬ 
tion of capital insofar as it has to do with saving. The most widely quoted 
of these authorities are the Scotch economist Lord Lauderdale, the American, 
John Rae, and the German, Friedrich von Hermann. There were shades of 
distinction among these authors’ contentions, but in general they were as 
follows: 

It is of importance to society as a whole to have goods as abundant as 
possible, whereas to the individual it is important that goods be valuable. 
Since value results from scarcity the promotion of self-interest tends to induce 


CAPITAL AS FACTOR IN PRODUCTION 


349 


persons to curtail production rather than stimulate it. Saving being a phe¬ 
nomenon of value instead of wealth the quickest way to diminish wealth is 
to save, while the quicket way to increase it is through public expenditures. 

Based on the philosophy of the kind here advanced has grown an ambi¬ 
tious program of the creation of capital by governmental action. In some 
instances it has even been argued that saving is an evil in its social conse¬ 
quences in that it retards rather than stimulates the growth of wealth. We 
have already examined this in connection with our discussion of the under¬ 
consumption theory of crises (Chapter IX, Part I, p. 232). In brief, the 
argument is that saving tends to retard the flow of money from the hands of 
the producers into those of consumers. Investments in capital goods accel¬ 
erated by savings of individuals, and the creation of reserves in corporations, 
serve to force business activities ahead of effective demand. Persons who 
would gladly purchase the great supplies of economic goods which, as a 
result, are experiencing a lagging demand stand empty-handed. Jobless and 
moneyless they become the objects of charity until the balance can be 
restored. Persons who hold to this view of saving feel that society pays too 
great a price to those who save. The fact is that they even doubt that saving 
should even be encouraged at all. 

These authorities, however, never doubt the greatness of the capitalistic 
manner of production. In fact they argue that society will never realize the 
full benefits of capitalistic production until we find a way to banish the 
malicious influence of saving. 

To the author the thesis here advanced is an illustration of the extremes 
to which some intellects will run when they find themselves challenging a 
long-accepted doctrine. The fact that it can be clearly demonstrated that 
saving is not in and of itself the source of capital is hardly enough to justify 
such an extreme conclusion as that of making it illegal to pay or accept 
interest on accumulated loanable funds. 

To say that saving is not a satisfactory explanation of the creation of 
capital is not the same as saying that private interest is not the necessary 
concomitant of the conservation of the supply of liquid capital and of the 
promotion of greater and greater achievements in the direction of satisfying 
our longing for easier and quicker ways of satisfying our desires. 

The creation of liquid capital—loanable funds—is as clearly a positive 
an act as that of inventing a machine. The decision not to spend a part of 
one’s income for immediate satisfaction, but instead to put it aside for a 
definite future reward is a positive act. Even if no reward were offered in 
the form of "interest” on the loan a certain amount of accumulation— 
saving if you please—would certainly occur. It is doubtful, however, that 
it would take the form of loanable funds. The opportunity of living on an 
independent income afforded by interest offered by borrowers of the accumu- 


350 


THE EXPANSION OF ECONOMIC CONCEPTS 


lated loanable funds provides motives which induce many persons who would 
not otherwise do so, to set aside a portion of their incomes for the definite 
purpose of securing that income on which they may live without having to 
work. Unless the reward is there it is hard to see that the loanable funds 
would come into existence. Since loanable funds are necessary to the creation 
and conservation of capital goods it appears necessary that a reward be 
offered to those who create those funds. The act of creating the supply of 
loanable funds is itself something more than merely saving; whereas the 
existence of that supply of loanable funds is not enough to account for the 
existence of capital. 

We should carefully observe, however, that the act of setting aside a p'Tt 
of one’s income for the purpose of creating a loanable fund reacts not on 
the money supply but on purchasing power. A change in the supply of money 
is more likely to be a cause of confusion than otherwise. In consequence, to 
study this aspect of the formation of capital it is necessary for us to resort 
to a device so frequent in economic analysis, namely, that of assuming a 
constancy of other forces while we are studying the phenomenon under 
examination. In this case the assumption is that of not only a constancy of 
the money supply, but also a constancy of the total purchasing power of 
the given community while the population remains stationary. With these 
assumptions before us we can examine more profitably the consequence of the 
act of creating lucrative capital. 

Since, by hypothesis, the money supply remains unchanged and the total 
purchasing power is unaltered, the act of setting aside a portion of one’s 
income for the purpose of lending it out can result in nothing more than a 
shift in the purchasing power. Instead of buying consumptive goods the 
part of the income loaned out tends to go into the purchase of productive 
goods. By the very nature of the case that must be so, for otherwise the 
borrower would have no source of extra income with which to pay the 
reward for the loan. Just how much he can pay will depend on how much the 
loan will increase his earning power. The amount of that increase will be 
measured by the added production—in value—made possible by the invest¬ 
ment of the loan in productive goods. If the amount that the borrower 
can offer is not enough to induce potential lender to grant the loan, then, 
of course, the loanable funds—liquid capital—will not be available. The cost 
of production of lucrative capital is, therefore, found to be the amount 
necessary to induce the creation of loanable funds—the setting aside of those 
portions of the incomes that go to make up the available supply of loanable 
funds. We find here, however, a phenomenon not materially different from 
that of the production of other economic goods. The amount necessary to 
induce persons to set aside the loanable funds is not the same for all persons 
and other agencies which have in their power to make them availab’e. Like- 


CAPITAL AS FACTOR IN PRODUCTION 


351 


wise different borrowers are able and willing to pay for these funds different 
rewards. Persons, however, who have funds to lend are not expected to 
accept less than the market offers simply because they may be willing to do 
so. Neither are the borrowers expected to pay more than the amount neces¬ 
sary to secure the loans. We therefore, find in connection with the phenome¬ 
non of liquid capital lenders’ schedules and borrowers’ schedules much as we 
do in connection with the price of other goods. Lenders, of course, appear on 
the supply side and borrowers appear on the demand side. The balancing of 
the lenders’ (supply) schedules against the borrowers’ (demand) schedules 
registers the market rate of interest in the same way as happens in the 
price of wheat or cotton. If the interest rate rises the supply of loanable funds 
tends to increase, for the simple reason that more persons are induced to put 
aside portions of their incomes, but fewer loans can be made, and vice versa. 
We find, therefore, an oscillation of the market rate of interest above and 
below a normal rate. It is in connection with that normal rate that we 
look for those forces which reveal the cost of production of lucrative capital. 

We find here the marginal lenders, and the marginal borrowers exerting 
their influences on the market rate, and representative borrowers and repre¬ 
sentative lenders exerting their influences on the normal rate. The phenomena 
associated with these influences have already received extended treatment in 
connection with the general treatment of market value and normal value. 

We arrive at a similar conclusion when we consider the cost of production 
of concrete capital goods. The cost of production of goods which are brought 
into existence for the definite purpose of making possible a larger income in 
the future present certain characteristics different from those which are the 
objects of immediate consumption. Little if any pleasure is found in the 
possession of the good itself except insofar as satisfaction is derived from the 
assurance of a steady income to be derived from the goods. This, however, 
is a very real satisfaction. Income from these goods, however, is not as sure, 
nor as steady as is the case with income from lucrative capital. The owner 
of productive capital is nearer the real source of the raw income. In fact, 
the income made possible by the productive capital may at times not be 
had at all unless the owner himself employs the capital good in connection 
with his own productive process. For instance, one employed as a fisherman 
may by giving thought develop a process by means of which he can double 
his catch in the same time as before. Yet no fish at all will be caught unless 
he exerts himself to some extent. It is true, however, that the owner of 
the improved process might lease it out, and thus secure an income very 
much as if it were lucrative capital. After all, therefore, whether engaged in 
the act of creating loanable funds or in the act of developing labor-saving 
devices, it is the value of the thing created that is the goal of the effort. 
Whether, therefore, we view the capital phenomenon from the standpoint 


352 


THE EXPANSION OF ECONOMIC CONCEPTS 


of concrete capital goods or from that of the loanable funds, we come out 
at the same place; viz., capital has value, and its owner can charge for its 
use. This capital value is the source of the income known to all students of 
the subject as interest. 

We can only conclude, therefore, that there is little if any reason why 
the government should outlaw interest. Fundamentally the production of 
capital follows laws similar to those which relate to the production of other 
commodities. The above remarks, however, are made only to open the way 
for a clearer view of the whole matter. 

(c) A Closer View of the Formation of Capital .—To gain the closer 
view it is necessary for us to return to our analysis of the transition from 
natural agents to capital goods, and their concomitants rent and interest. It 
will be remembered that in that gradation we find at least six different value 
situations (see p. 489). Even though exact representations of each of these 
situations can not be discovered, an assumption which I am unwilling to 
make, yet for scientific purposes they are just as real. They may at least be 
thought of as limits toward which tendencies to approach certainly do exist. 
For the sake of scientific analysis we can study each of these situations with 
assumption of their existence and thereafter make corrections to care for 
any variations in actuality. In connection with the first of these assumptions 
we find the phenomenon of pure rent attributable to natural agents. In con¬ 
nection with the last, we find that of pure interest attributable to the phe¬ 
nomenon of capital. Let us therefore dissect each of these so as better to 
appreciate the relation of cost of production to capital. 

Clearly the natural agent, since it has no cost of production, presents 
nothing of difficulty. It has a calculable value, however, only in the light of 
an assumed interest rate. The higher the interest rate the lower the value, and 
the lower the rate the greater the value. If through some happy coincident 
the interest rate should fall to zero the value of a natural agent would rise 
to infinity. With an assumed interest rate, a phenomenon which must receive 
attention later, we can give definiteness to the value of a natural agent. 
Without it we cannot do so. We can see, for instance, that if an indestruc¬ 
tible natural agent nets an income yearly of, say, $1,000 its value capitalizes 
at $20,00 when 5% is the interest rate. The natural agent would be expected 
to sell for at least that much. The income, however, is pure rent; but for the 
purpose of discovering the value of the natural agent we are forced to treat 
it in the same way as if we were calculating the value of an investment in 
capital goods. What right, however, have we to' make any assumption at all 
with regard to an interest rate when we are talking about natural agents? 
All that we can say is that persons with loanable funds have the option of 
investing them either in capital goods or in natural agents. 


CAPITAL AS FACTOR IN PRODUCTION 


353 


Contrast the above with that of a good which has a cost of production. 
Let us assume that its gross income is $2,000 instead of $1,000 a year. 
Further, let us assume that it requires $1,000 to keep the thing always intact. 
It is clearly evident that the value of the second article is exactly the same 
as that of the natural agent, the income from which is $1,000 a year. The 
fact, however, that the second article has a cost of production means that 
it would not exist at all unless man had exerted himself to bring it into 
existence. It is therefore a capital good. The further fact that it is destruc¬ 
tible and replaceable gives it attributes most usually characteristic of capital 
goods. It is in connection with a phenomenon like this that we can center our 
attention on forces which are at work in relation to the cost of producing 
capital. To lighten up the discussion of this point the following quotation 
from Gide will help us to see the point more clearly: 

"Even in the case of capital employed productively (e. g. a plane) the notion of pro¬ 
ductiveness is said to be equivocal, for it implies material productiveness (i. e. boards). Now 
though it is obvious that the employment of capital enables labour to produce more, both 
in quantity and in utility, it is by no means proved that it enables it to produce more value. 
To create abundance is not to create value (p. 42). Technical productiveness must not be 
confounded with economic productiveness. Does machinery confer upon the products it makes 
a greater value than that of the hand-made product? Yes, if there is a monopoly; no, if 
there is competition. In the latter case the products whose price is reduced to the cost of 
production acquire no extra value beyond that represented by the cost and depreciation of 
the machinery. It is intelligible that the price of boards must include the value necessary to 
repair the machine or plane—the allowance for depreciation;—but it is impossible to under¬ 
stand by what natural law it ought to include an extra value that would be the income of 
the machine or plane.” (Principles of Political Economy, p. 403.) 

Are, therefore, capital goods worth more than they cost, or are they worth 
exactly what they cost? If the value of capital goods is based on a capitaliza¬ 
tion of an income in excess of their costs, then how can we say that capital 
has a cost? Truly the value would not be there if the goods had not been 
produced. But can we say that of the goods had the extra value not been 
there? If we are correct in assuming that the normal value of a good which 
is produced under free competition must correspond to the cost of production 
of representative firms (see p. 101), it is inaccurate to assume that any last¬ 
ing value exists above that cost. If, therefore, we base a valuation on an 
income above that cost, which may be represented in the given illustration 
by the amount in excess of the depreciation charge, we are placing a value 
on a thing which does not have a cost. Whenever, therefore, capital goods 
have an earning power above the cost of production, or, if you please, the 
cost of continuation, that earning power must logically be due to a peculiar 
advantage which it has over other goods of the kind less favorably placed. 
The valuation, therefore, of an income above the cost is either a valuation of 
a profit or of a natural advantage. It is either a competitive or a monopoly 
profit, or it is a rent. We are forced to the conclusion, therefore, that the inter¬ 
est phenomenon is found not in the extra $1,000 but in the $1,000 required to 
keep the goods intact. Many a business man has learned to his sorrow that to 


354 


THE EXPANSION OF ECONOMIC CONCEPTS 


be the case. Without special advantage to assure an income with which to 
pay the reward for funds borrowed they have found themselves faced with 
bankruptcy. 

It may appear that with a conclusion like this we have explained away all 
possibility of an interest payment at all. JFor it is certainly true that in the 
great preponderance of treatises on interest the assumption is made that 
interest is a payment out of income after the depreciation charge has been 
deducted. The fact is that most actual payments which are dubbed interest 
are thus acquired. That fact, however, should not hinder our looking deeper. 
The deeper search certainly makes a strong case against the source of interest 
being that of an income above the cost of production. Since capital itself 
is now always a part of the cost of production we are not placing ourselves 
in such an untenable position after all. Not to find interest, the cost of 
capital, in the depreciation charge is to place one in the illogical position of 
assuming that capital has no cost. 

To gain a clearer view of this let us return to our exposition of the 
nature of capitalistic production (p. 480). It will be remembered that we 
found that it is timeliness rather than indirectness that is the test of capitalis¬ 
tic production. Mankind has from time immemorial sought longingly for 
easier and simpler means of satisfying his desires. Anyone who has found 
a way of satisfying one of these longings and at the same time retained 
property in the process has placed himself in the happy state of being able to 
exact a tribute from the rest of his fellows. At the same time those making 
use of the process can and will well afford to pay the tribute since their own 
incomes are increased by its use. Regardless of how much or how little 
trouble the creater of one of these processes has experienced in its production 
the income from it will measure its value. That will be true whether he 
uses it in his own business or leases it to others. It is the labor saved by the 
discovery rather than the amount expended on its production that accotints 
for its value. 

But capital helps to produce capital. So nearly universally has that come 
to be the case that now whenever we speak of the cost of production of any¬ 
thing we are of necessity forced to think of capital as one of the factors of 
that cost. Our inquiry here is to discover the nature of that cost with regard 
to capital itself. 

One who has discovered quicker means of accomplishing a definite task 
has something the value of which is measured by the superior quickness of 
that accomplishment. If he employs it himself he himself gains the advantage 
in his own productive act. If he leases it he gains an income at least as great 
as he calculates he can obtain by using the thing himself. If he sells the 
right to use it, he gains a purchasing power which will enable him to pur¬ 
chase another process which is equally as advantageous. If he lends out the 


CAPITAL AS FACTOR IN PRODUCTION 


355 


purchasing power represented by the sale price he enables another to purchase 
something which will serve as capital—productive capital—in his business. 
Thus whether we think in terms of capital goods or lucrative capital we 
arrive at the same conclusion—that it is the value of the capital with which 
we are concerned. The cost of the capital is the amount of exertion neces¬ 
sary to bring into operation one of the processes which quickens produc¬ 
tion. The value of the capital is measured by the amount of the acceleration. 

To attempt to generalize on this cost would be futile, except as we gen¬ 
eralize with regard to the cost of production of anything. A thing of very 
little value might be the result of excessive expenditure of effort, while a thing 
of great value might come as a happy thought of a soldier of fortune. The 
marginal producer and the representative firm, however, probably play as 
great a part in the cost of production of capital, and therefore have influence 
on its value in the same way as they do on the value of anything else. To 
generalize, therefore, on the cost of production of capital would result in 
nothing more than a restatement of the principles which we have explained as 
controlling market value and normal value. 

The Cost of Capital and the Doctrine of Surplus Value.—W e 
can see, from the above explanation of the cost of production of capital, how, 
without a critical view of capital, the Marxian socialists have attributed a 
surplus value to capital. Many owners of lucrative capital are in fact living 
on the extra income that sometimes comes in from capital above its cost of 
production. When they do, however, they are really living on a surplus 
value. The surplus value, however, as we have seen, is not accurately thought 
of as a capital value. It is more logically thought of as a rent, or a profit 
(monopoly or otherwise). If the proper social treatment were accorded those 
sources of income it is hard to see any excuse for antagonism to capitalism. 
The ingenious savage who pipes the water to the village has performed a 
service well worthy of his reward. Capitalistic production tends always to do 
that sort of thing. 

Capital Classified. —We are now ready to make a classification of 
capital goods against the background of concepts and distinctions herein 
contained. 

1. Fixed v. Variable Capital .—The distinction between fixed capital and 
variable capital conforms closely to our distinction between goods which have 
a cost of production and are indestructible and those which have a cost and 
are destructible. Very few goods have exactly equivalent durabilities. Raw 
materials are of course destroyed in one use. But not all raw material goes 
through exactly the same transformations. For instance the using up of coal 
in the operation of a steam engine is different from the using up of raw 


356 


THE EXPANSION OF ECONOMIC CONCEPTS 


cotton in the manufacture of textiles. In the one case the article is gone 
forever, while in the other it endures in a different form to appear in another 
use. Yet each requires a replacement fund of one hundred per cent. The term 
variable capital is employed to designate those sorts of capital goods that arc 
used up in the process of manufacturing other articles. Sometimes the term 
variable capital is used in another sense—that of shiftability (or mobility), 
the ease with which it can be transferred from one use to another. As we 
shall see in a moment that term does better service in another connection. 

Capital goods which are capable of being used again in the same produc¬ 
tive process are spoken of as fixed capital. The durability of capital goods 
presents one of the perplexing problems of industry. Its perplexities present 
at least three aspects. They are (1) the relation of the original cost to dura¬ 
bility, (2) accuracy in the calculation of a depreciation reserve, and (3) the 
obsolescence phenomenon. 

With regard to the first of these, Professor Gide, who has done some of 
the best writing on this subject, has the following to say: 

"There is a great advantage to production in employing very durable capital. However 
great, in fact, may be the labour required to set it up, and however slight may be the labour 
expected to be saved each year by its assistance, sooner or later a time must necessarily come 
when the labour saved is equal to the labour expended. When that momnt has arrived, the 
capital will be redeemed, which means that henceforth the labour saved will constitute a net 
gain to society. From that point, for as long as the capital lasts, the services it renders will be 
rendered for nothing. So the progress of civilization tends to replace the short-lived capital 
by that which is more durable.” (Principles of Political Economy, p. 109.) 

(2) The services of capital could continue to be free only if the capital 
after once being created were indestructible. Since most capital is capable of 
being destroyed it becomes necessary to set aside from the income a replace¬ 
ment fund capable of keeping it intact or else society will lose its benefits. 
In the absence of a money economy we can think of that reserve taking the 
form of a portion of the labor saved. That is to say, enough time would 
have to be taken out of the time saved to keep the instrument in repair. 
Under a money economy the replacement charge takes the form of a charge 
against the money income. If we could know exactly how long the instru¬ 
ment would endure and exactly how much it would cost to secure another 
equally as efficient when it is worn out the problem would not be so per¬ 
plexing. In fact, however, we can not know with accuracy either of these. 
The depreciation account, therefore, becomes a problem of at least two 
variables neither one of which lends itself to any standard of measurement. 
We know, however, that unless a depreciation account large enough to cover 
the wastage of assets is set up man will lose the benefit of some of the gains 
already made by capitalistic production. 

(3) The problem is further complicated by the risk that the instrument 
will become useless before it is worn out. The obsolescence problem is really 
more perplexing than that of durability. The modern world offers many 


CAPITAL AS FACTOR IN PRODUCTION 


357 


monuments to man’s foolhardiness in building capital goods that long outlast 
their usefulness. To quote Gide again: 

"Utility, as we know, is unstable; and what seems most firmly established may vanish 
after a certain time. We cannot imagine that the utility of water and of the aqueduct that 
conveys it can ever disappear; yet the great aqueduct called Pont du Gard, built by the 
Romans for the town of Nimes, is nothing now but a magnificent and useless ruin. That is 
because the water of the Rhone has been brought to Nimes. When we drive a tunnel or dig 
a canal we have no guarantee that traffic will not take some other route after a century 
or two. Now, if capital sunk in the tunnel is not redeemed by the time this change takes 
place, a great deal of labour will have been expended uselessly. It is prudent, therefore, in 
view of our uncertainty about the future, not to build for eternity. From this point of view 
the use of too lasting a form of capital may be a dangerous operation.” {Ibid. p. 111.) 

We can hardly give too great a praise to the magnificence of the capital¬ 
istic order but we must never underestimate the difficulty of its successful 
operation and administration at the peril of the loss of many of its benefits. 

2. Specialized v. M oble Capital .—The distinction between specialized and 
mobile capital is equally as significant as that between fixed and variable 
capital. True it is that in most instances fixed capital will be specialized. 
It cannot be said with equal assurance that variable capital will be mobile,, 
although frequently that will similarly be true. Completely specialized capital 
is that suited only to one use or purpose. A railroad bridge, for instance, 
could hardly have any other use than that of supporting the passage of trains 
over the stream or ravine. Fixed capital does, however, at times adapt itself 
fairly readily to other uses than that for which it was originally intended. 
Metal pipe, may, for instance, be employed in any one of many uses. Capital, 
however, does not assume complete mobility until it becomes purchasing 
power. 

An easy error here is to assume that liquid capital is exactly synonymous 
with money. Money, however, is best thought of as specialized capital devoted 
to the service of enabling purchasing power to function readily. Money is in 
fact one of the most specialized of all capital goods. Purchasing power, 
however, is the most mobile. It is through the agency of liquid capital that 
most of the characteristics usually attributed to capital are found. Here we 
find the replacement fund which enables the wise administrator to keep 
his capital operating efficiently. Here it is also that we discover the phenome¬ 
non of saving and investing. When once capital becomes liquid it may retain 
its lucrative attributes in many ways. It may flow into natural agents and 
become the basis of rents. It may go into the formation of monopolies and 
claim monopoly profits. It is here that the phenomenon of interest makes 
its appearance as a percentage of money values. Because of these facts a 
plausible explanation of the interest phenomenon as distinct from rent adds 
another perplexity to the science of economics. A consideration of that 
aspect of capital—its shares in distribution—must await its turn in our treat¬ 
ment of the economics of distribution. 










CHAPTER V. 


THE POSSIBILITY OF A MORE EFFECTIVE SYSTEM OF 
CREATING CAPITAL 

The Problem of Changing the Normal Supply of Capital.— 
Whether mankind may be expected to develop a more efficient system of 
creating capital presents a challenging question. To be handled intelligently, 
however, it must be approached from two points of view, namely, that of 
lucrative capital and that of concrete capital goods. 

1. Balancing the Supply Against the Demand in Connection with Lucra¬ 
tive Capital .—The balancing of the supply and demand schedules in con¬ 
nection with lucrative capital has already been alluded to (p. 501). In 
connection with the borrowers’ and lenders’ schedules we must recognize the 
influence of the marginal borrowers and marginal lenders as indicators of the 
market rate of interest. Likewise we must recognize the influence of the 
representative borrowers and the representative lenders whose influence takes 
form in the normal rate of interest. Only a casual examination of the varia¬ 
tions in interest rates on prime securities will reveal both of these influences. 
The oscillations appear to be roughly from something less than 3 /i % to 
something over 5*4%. Probably 4% is a good assumption for a normal rate 
on prime securities. Although absolutely pure interest might show a rate 
somewhat lower than that. Why, however, should society be satisfied with 
these rates? Why not give attention to the laws which relate to the creation 
of capital so as to change the normal rate and thus possibly have the oscilla¬ 
tion above and below .4% instead of 4%? That is to say why not fix it so 
that the rate will be $4 a thousand instead of $4 a hundred. If capital con¬ 
tains all the magic properties attributed to it, might not an effort of that 
kind be well worth while? The problem before us, of course, is the ap¬ 
plicability of the theory of changing normals to the interest rate and its 
concomitant, the supply of capital. 

2. The Balancing of the Supply Against Demand in Connection with 
Concrete Capital Goods .—Supply and demand schedules in connection with 
concrete capital goods cannot be seen in as clear-cut a manner as those of 
lucrative capital. The truth seems to be that the payment of interest de- 


359 


360 


THE EXPANSION OF ECONOMIC CONCEPTS 


velops from that of concrete capital goods while the interest rate applies 
more definitely to lucrative capital. 

Concrete capital goods are bought and sold on the market in the same 
way as any other economic goods. The operation of the law of supply and 
demand, therefore, in connection with them assumes the same form as that 
with the price of any good whether consumptive or productive. 

What we find is an equilibrium of supply and demand which reflects 
against a background of lucrative capital. In the first place consumable 
goods as a whole may be increasing or decreasing in relation to the supply 
of producers’ goods. We may safely assume, therefore, that if consumable 
goods are not increasing in relation to the increase of productive goods we are 
not gaining from capitalistic production. If productive effort as a whole 
is showing a gain, i. e., if the same time spent at any employment tends to 
show on the average a larger net return in satisfaction we are experiencing 
a change for the better in the utilization of capitalistic production. On the 
other hand, if a given amount of effort shows a smaller amount of satisfac¬ 
tion we are losing ground in capitalistic production. A summary of the 
actuality will probably show a correlation between these forces and the 
interest rate. That is to say, when the rate oscillates downward to 3% 
margin humanity is tending to live on a higher plane, while when it swings 
upward to, say the 5% margin we are not so well off. Unless there is this 
correlation between lucrative capital and concrete capital goods it will be 
difficult to demonstrate any social benefits of saving. 

Even without statistical verification there is evidence to show that the 
correlation does exist. It makes its appearance in the evident fact that lucra¬ 
tive capital tends to be directed into concrete capital goods of any particular 
kind only so long as its net return is at least as large as the net return from 
its investment somewhere else. This fact tends to prevent the market value 
of any particular form of capital goods from varying widely from its normal 
value, as it does to prevent the earning power of any particular use to which 
capital goods may be put from varying widely from any other use. To be 
more specific, if the net return from a newly developed plane (in a planing 
mill) has been found to be greater than that of an older type of plane, the 
demand will tend to center on the new one. The saving thus realized will 
tend to become a part of the social gain from the improved article. Similarly, 
if investments in, say, airplanes tend to net greater returns than investments 
in automobiles the demand will shift to airplanes. All of these shifts tend 
to reflect themselves in the securities market. Persons who discover a possi¬ 
bility of paying larger returns from lucrative capital because of the possibility 
of employing the funds more profitably in new opportunities offered in the 
field of concrete capital goods will tend to bid up for those funds. After a 
time the investment market will yield to their pressure. And so the process 


POSSIBILITY OF A MORE EFFICIENT SYSTEM 


361 


continues. The shift from one use to another will tend to increase the value 
of capital in those places from which it shifts, and lower it in those places 
into which it has shifted. 

The supply of lucrative capital, therefore, tends to move back and forth 
very much like the waves of the sea, never rising very much above or falling 
very far below an established norm. The question for us to decide here, how¬ 
ever, is whether or not the relation of the supply of capital to human desires 
in fact resembles the norm of the sea level or whether or not man can by 
giving thought to the laws which control its supply change the norm, 
around which it tends to oscillate to man’s own advantage. 

Changing the Normal Supply of Lucrative Capital. 1. A 
Problem in Compound Interest .—The rate at which any given amount 
will accumulate when left undisturbed might lead one to conclude that 
the problem of increasing the supply of lucrative capital and thus 
lowering the normal rate of interest is a comparatively simple one. Any 
amount, however small, left to accumulate at a compound interest of any 
rate will grow into a fund of any amount, however great, if left undisturbed 
for a long enough period of time. It would seem, therefore, that the problem 
of increasing inordinately the supply of loanable funds is merely that of 
initiating the process in such a way as not materially to injure the present 
generation and leaving it to the benefit of a later generation. Each generation 
should thereafter find it less difficult to do a similar thing for the next so 
that conceivably within the period of a few centuries, mankind might be¬ 
come immeasurably wealthy. 

A few illustrative figures are enough to show what is meant: 

$1 will at 3^4% compounded annually equal in 50 yrs. - - $5.58 

$1 will at 4% compounded annually equal in 50 yrs. - - $7.10 

$1 will at 5 % compounded annually equal in 50 yrs. - - $11.46 

$1 a year will at 3 /z% compounded annually equal in 50 yrs. $13 5.5.8 
$1 a year will at 4% compounded annually equal in 50 yrs. $15 8.77 
$1 a year will at 5% compounded annually equal in 50 yrs. $219.80 

It is because of calculations such as these that insurance companies, in¬ 
vestment bankers, and other loan agencies make the attractive promises that 
they do to persons who will deposit regularly with them relatively small 
portions of their incomes. For generations they have been able to live up 
to their promises, and thus far there does not seem to be any sign of a 
significant decline in the normal rate of interest. An insurance company will 
gladly agree to reimburse one for savings left with it at a guaranteed rate 
of 3 l /z % interest compounded annually—or even in some cases better than 
that. It would seem that these promises held out by conservative savings 


362 


THE EXPANSION OF ECONOMIC CONCEPTS 


institutions would long ago have had the effect of building up such a 
tremendous supply of loanable funds that the normal rate of interest would 
ere this have fallen. Thus far in the history of mankind man’s will to enjoy 
and otherwise to consume has been so indomitable that all that can be said 
is that the interest rate oscillates above and below a normal rate, which 
appears to be somewhat more than 3^2% a year. If, therefore, we wait on the 
inducements to save offered by the private institutions to individuals it is 
doubtful that the normal rate of interest will fall very much more in the 
future than it has in the past. 

There is, however, one agency that could logically do the trick. That 
agency is the government. At this time the United States government spends 
approximately $700,000,000 in support of the army and navy. Now let us, 
for the sake of argument, assume that a program of international limitation 
of armaments finally becomes established and that as a result our expenditures 
for those purposes are diminished by as much as $300,000,000 a year. With¬ 
out serious consequences to anyone, that fund could be thrown into the pool 
of loanable funds to be lent at the prevailing rate of interest. If that amount 
were allowed to accumulate at a rate of 3 ^2 % compounded annually, and if 
the number of families should increase to as many as 40,000,000 within fifty 
years, at the end of the fifty-year period a fund of $1,000 each could be 
distributed to the families, and in addition more than $600,000,000 would 
be left over with which to start the next "fifty year plan.” 

To say that under a program of that kind the normal rate of interest 
would not fall is to state an evident fallacy. To say that it could not be done 
is to dispute the likelihood of a successful program of limitation of arma¬ 
ments. To say that under a program of limitation of armaments such a dis¬ 
position should not be made of the funds which are released, is to raise 
an important question of governmental economic policy. 

2. Forces Which Tend to Neutralize the Effects of Accumulating Funds. 

(1) Loss of the Principal .—Although we are forced to admit that one of 
the influences which would tend to prevent the successful operation of a 
plan such as that hereby suggested is that of loss of principal, yet in pure 
theory that force should be disregarded. By hypothesis we are dealing with 
the phenomenon of pure interest. That means, of course, the rate which has 
to be paid for capital independently of any risk of loss. Where the risk of 
loss makes itself felt a larger gross rate is charged. The losses and gains, 
therefore, tend to offset each other. Hence for scientific purposes we can 
entirely disregard the chance of loss of principal' and assume that the ac¬ 
cumulating loanable fund will be loaned out as it comes into existence at 
the rate which is possible for those who borrow the capital to pay out of 
extra earnings made possible by the availability of the loanable funds. 


POSSIBILITY OF A MORE EFFICIENT SYSTEM 


363 


(2) The Tact that the Amount Set Aside Cannot be Loaned at the As¬ 
sumed Kate. Thus far in the history of man all of the available funds have 
been able to be placed at the assumed rate of 31/2%. That fact, however, 
may be thought of as due to the fact that there has never before been any 
conscious plan of making a positive effort to reduce the normal rate. As 
hundreds of millions of dollars are each year added to the accumulated loan¬ 
able reserves, we may well ask ourselves what to expect with regard to the 
likelihood of finding an outlet for those funds; then, too, if the rate of 
interest did fall, whether or not it would be a rapid fall. Any fall in the 
rate would react against the totals. Since the demand for capital is an elastic 
demand, any fall that might occur would certainly be gradual. 

The possible effects of such a phenomenon as this has been visualized 
as follows: 

"It must be desired also as a stimulus to production; for by continually lowering the 
hiring price of capital, and consequently the expenses of production, it must facilitate the 
execution of undertakings that were formerly impossible. Here are lands to be cleared, and 
houses that one would like to build to house the workmen, but it is well known that land and 
houses will not bring in more than 3%. If, then, the current rate of interest is 5% it will be 
impossible to get capital for these undertakings, for they could only be undertaken at a loss. 
So they will be left alone. But suppose that the rate of interest falls to 2%; there will im¬ 
mediately be a rush to execute them. Turgot compared a fall in the rate of interest, in a cele¬ 
brated simile, to the gradual fall of waters that allows cultivation to extend over new lands.” 
(Gide: Principles of Political Economy, pp. 414-415.) 

Another authority has visualized the possibilities of utilizing an increas¬ 
ing supply of capital in the following language: 

"By a sufficient outlay of capital each house could be supplied with what it does require, 
and relieved of what it does not, much more effectively than now, so as to enable a large part 
of the population to live in towns and yet be free from many of the present evils of town 
life. The first step is to make under all streets large tunnels, in which many pipes and wires 
can be laid side by side, and repaired when they get out of order, without any interruption 
of the general traffic and without great expense. Motive power, and possibly even heat, might 
then be generated at great distances from the towns (in some cases in coal mines), and laid 
on wherever wanted. Soft water and spring water, and perhaps even sea water and ozonized 
air, might be laid on in separate pipes to nearly every house; while steam-pipes might be used 
for giving warmth in winter, and compressed air for lowering the heat of summer; or the 
heat might be supplied by gas of great heating power laid on in special pipes, while light was 
derived from gas specially suited for the purpose or from electricity; and every house might 
be in electric communication with the rest of the town. All unwholesome vapours, including 
those given off by domestic fires which were still used, might be carried away by strong 
droughts through huge chimneys into higher air. To carry out such a scheme in the towns 
of England would require the outlay of a much larger capital than has been absorbed by our 
railways. This conjecture as to the ultimate course of town improvement may be wide of the 
truth; but it serves to indicate one of very many ways in which the experience of the past 
foreshadows the broad openings for investing present effort in providing the means of satis¬ 
fying our wants in the future.” (Marshall: Principles of Economics, IV, VII, 2 Note.) 

It therefore takes only a little imagination to visualize the great things 
that might be accompanied by an increased supply of capital which could 
be loaned at lower and lower rates of interest. If mankind would once begin 
to think of the possibilities the better use of funds which are now sacrificed 
on the alter of human hatred, and employed to multiply human misery, 
what a great vista would open up before his eyes. 


364 


THE EXPANSION OF ECONOMIC CONCEPTS 


(3) Increased Consumption .—The danger of raids on the treasury is ever 
present. If the government should become a lending agency instead of a 
borrowing agency, as a program here suggested would really contemplate, 
it is hard to see that the danger of raids on the treasury would be lessened. 
Again, however, we are forced to remind the reader that by hypothesis we 
are assuming that danger to have been forestalled. If by any chance powerful 
lobbies were successful in dissipating the incomes from the investments of 
the yearly accumulating reserves in the direction, say, of reduction of taxes 
and using the income to defray governmental expenses we should unquestion¬ 
ably be thrown off the track which leads in the direction of a lower marginal 
interest rate. Man is really, on the whole, very short-sighted in his attitude 
toward pressing needs. The fact, however, that the accumulating funds 
would continually be expended might lead to counteractive influences. That 
is to say, the money will not be piling up, but will be loaned out. Those 
agencies borrowing the capital would demand labor. That fact would reduce 
unemployment, and slowly but surely might bring common man into a fuller 
and richer existence. In time this latter influence might be expected success¬ 
fully to beat down the parasitical raids on the treasury and turn the full 
sweep of public opinion in the direction of the original objective. 

(4) The Rise in the Prices of Natural Agents .—We have already shown 
(p. 342) the intimate relation between the interest rate and the value of a 
natural agent. The one great source of many men’s ability to live without 
working at all is that of pure rent. If society could find a way to lower the 
normal rate of interest, unless it were very far-seeing, the result would 
largely, if not almost entirely, fall into the hands of owners of natural agents. 
At }/z% a natural agent which nets an income of say $3 50 a year would 
be worth $10,000. If the interest rate should fall to \ l /i% the value of that 
natural agent would rise to $20,000, and so forth. It is entirely possible, 
therefore, that a social order which did actually constructively and positively 
effect a reduction in the normal rate of interest would merely increase the 
wealth of the landed proprietors, and owners of other natural agents. Any 
social order that had the vision and foresight consciously to work out a plan 
of lowering the normal rate of interest would be expected to have intellectual 
acumen enough to break the grip of the private owners of natural agents 
so as to prevent them from defeating the very purpose of the reforms. 

Yet it is conceivable that the reform might be instituted by those very 
owners of the lands and other natural agents for the definite purpose of 
increasing their wealth because of the fact that a lower interest rate does 
augment the value of a natural agent. All of which goes to show the vital 
necessity of separating the land problem from that of capital in any pro¬ 
gram of social reform. 


POSSIBILITY OF A MORE EFFICIENT SYSTEM 


365 


(5) Institutions with Guaranties Based on a Calculated Minimum In¬ 
terest Kate .—Opposed to the owners of natural agents are those institutions 
which have built up gigantic financial obligations based on a calculated 
minimum interest rate. It is well known that most of the great insurance 
companies make their compound interest calculations on an assumed rate of 
not less than 3*4%. They really expect to make considerably more than 
that by a judicious placing of their funds. Now if the government actually 
did offer on the investment market as much as $300,000,000 a year, the 
agents of the government would be in competition with the insurance com¬ 
panies, and other investment institutions, in the market for loans. For the 
first year or two that competition might not be felt keenly. In time, however, 
it would be felt, or else our assumption is false that it is possible to lower 
the normal rate of interest. 

If given time, however, the insurance actuaries might be expected to re¬ 
work their tables so as to accommodate themselves to the change. More 
than likely, any sudden reduction in the normal rate of interest might be 
expected to jeopardize the very existence of those institutions which have 
built up their business on a calculated minimum rate of interest. In the battle 
for the change, therefore, we should expect the lobbies for the insurance 
companies to match their strength against those of the land owners. The 
social objective, however, lies beyond the interest both of the insurance com¬ 
panies and the landed proprietors. The objective is one for which it is hard 
to find a sponsoring agency. Yet as economic scientists we are forced to 
recognize the existence of the possibility. It is that social objective that 
concerns us now. 

3. Theoretical Consequences of the Change. (1) The Bastiat Thesis .— 
That which we have been picturing as a possibility, to the mind of Fred¬ 
erick Bastiat was already a reality. He thought that independently of any 
positive plan of social action the will to save might be expected to effect 
a continuous decline in the interest rate accompanied by a continuous rise 
in wages. Employing figures to illustrate his point Bastiat offered the fol¬ 
lowing tabulation of the expected result: 


Total Product Capital’s Share Labour’s Share 

First period_ 1000 500 (50%) 500 (50%) 

Second period_2000 800 (40%) 1200 (60%) 

Third period_-3000 1050 (35%) 1950 (65%) 

Fourth period_4000 1200 (30%) 2800 (70%) 


"The proof is very simple—too simple perhaps. It rests entirely upon the law concerning 
the lowering of the rate of interest, noted by Turgot and other economists long before Bastiat’s 
time. If capital, instead of asking 5 per cent., only demands 3 per cent., then its share is dimin¬ 
ished, and any further diminution of its share must mean an increase of the proportion avail¬ 
able for labour.” (Gide and Rist: History of Economic Doctrines, p. 340). 

Neither was Bastiat worried about the owners of natural agents drawing 
an undue share of the gain. In fact Bastiat along with H. C. Carey laboriously 
attempted to explain away the phenomenon of rent. If we could find it 








366 


THE EXPANSION OF ECONOMIC CONCEPTS 


possible to accept Bastiat’s thesis of the non-existence of rent we could 
possibly accept his conclusion with regard to the effect on wages of a de¬ 
clining interest rate. Even then, however, we could hardly agree with him 
that it would occur except as a consequence of a conscious social policy to 
that end. 

(2) The Rodbertus Thesis .—Based on a similar line of approach Karl 
Rodbertus, the German socialist, came to a diametrically opposite con¬ 
clusion. According to Rodbertus, under the automatic system and its neces¬ 
sary concomitants, an increasing supply of capital means more and more 
exploitation of the laborers by the capitalists. Instead, therefore, of benefiting 
by the change, laborers, under the established order are now, and may be 
expected in the future increasingly to be exploited by the capitalists. 

"Theorist as he was, a simple deduction was all that was needed to convince him of the 
truth of this view. The rate of wages, we have already seen, is determined by the interaction of 
demand and supply in the labor market. The market price of labour, however, like that of 
any other product, is always gravitating toward a normal value—this normal value being 
none other than Ricardo’s necessary wage. 'The share of the product that falls to the lot of 
the producer both in an individual instance and as a general rule is not measured by the amount 
which he himself has produced, but by the quantity which is sufficient for the upkeep of his 
strength and the upbringing of his children.’ This celebrated 'brazen law’ became the pivot of 
Lassalle’s propaganda, although it was never definitely recognized by Marx. 

"Granting the existence of such a law, and admitting also that the amount produced by 
labour is always increasing, so that the mass of commodities produced always keeps growing, a 
very simple arithmetical calculation suffices to show that the total quantity obtained by the 
workers always remains the same, representing a diminished fraction of the growing totality.” 
(Ibid. pp. 42 5-26). 

Rodbertus, therefore, did not question the fact that an increase in the 
supply of capital would bring about a potential increase in wages. But he did 
doubt that the laborers would ever get that increase. 

Gide and Rist have very kindly answered both Bastiat and Rodbertus 
for us in the following language: 

"But a relative diminution of this kind will not prevent capital drawing an absolutely 
greater share, provided the total produce goes on increasing, as is the case in every progressive 
community. Its total share, though on the increase, may be decreasing relatively to the share 
that goes to labour. For example, the total product may be tripled, capital’s share having 
doubled in the meantime, while labour’s portion is quadrupled. Unfortunately this is a purely 
sophistical argument. The figures given in the table are simply invented to meet the needs of 
the case. Even the universality of the law concerning the rate of interest is open to dispute. 
Economic history seems to point to a series of periodic oscillations of the rate.” (Professor Gide’s 
comment on Bastiat. I bid. p. 341). 

"In the first place, doubt as to the validity of the 'brazen’ or 'iron law of wages’—upon 
which the theory is based—is entertained not merely by economists, but also by socialists. And 
even if it were true, Rodbertus’s proof would still be inconclusive, for the workers’ share of the 
total product depends not upon one factor alone, but upon two—the rate of wages and the 
number of workers. Rodbertus’s error and Bastiat’s are very similar. Bastiat had tried to deter¬ 
mine the capitalists share of the total product by taking account of one fact only, namely, the 
rate of interest, whereas he ought to have taken the amount of existing capital into considera¬ 
tion as well. 

"But we must admit that although the arguments used by Rodbertus are scarcely more 
reliable than Bastiat’s, his theory itself is nearer the facts as judged by statistics. No amount 
of a priori reasoning without some recourse to statistics can solve the problem. Statistics them¬ 
selves seem to prove that labour’s portion, in some countries at least, has shown signs of dimin¬ 
ishing since the beginning of the present century. 


POSSIBILITY OF A MORE EFFICIENT SYSTEM 


367 


"This does not necessarily mean that the worker must be worse off, for it may well happen 
that a diminution in the general share obtained by labour is accompanied by a growth of indi¬ 
vidual wages. All that we can conclude is that wages have not increased as rapidly as has 
capital’s share, but this has not prevented the workers sharing in the general growth of pros¬ 
perity.” (Professor Rist’s comment of Rodbertus, Ibid. pp. 426-27). 

Our own conclusion is that if a constructive plan of social control is 
applied to the income from natural agents so as to prevent the landed 
proprietors and their kind from getting the benefits of a lowering interest 
rate through a rise in the value of land, and other natural agents, we may 
expect the consequences to be much as pictured by Bastiat. Without that 
plan of positive control the statistical verities as alluded to by Prof. Rist 
may be expected to continue. 

Changing the Normal Supply of Concrete Capital Goods.— 
Treatment of the subject of the changing normal interest rate from the 
standpoint of lucrative capital is only half of the problem. We have already 
seen that there is a correlation between the two, and that an increase in 
the supply of lucrative capital may be expected to be accompanied by an 
increase in the supply of concrete capital goods. But the problem of the 
introduction of labor saving devices contains points of no small importance 
in and of itself. 

1. The Objective. —-(1) The Sismoitdi Thesis. The arch opponents of 
the introduction of labor-saving devices is Sismondi. His arguments have 
been repeated many times during the 19th and 20th centuries. He attempted 
to reduce the whole proposition to an absurdity. 

"Suppose, says Sismondi, that England succeeded in tilling her fields and doing all the 
work of her towns by means of steam power, so that her total products and revenue remain 
the same as they are to-day, though her population is only equal to that of the Republic of 
Geneva. Is she to be regarded as richer and more prosperous? Ricardo would reply in the affirm¬ 
ative. Wealth is everything, men nothing. Really, then, a single king, dwelling alone on the 
island, by merely turning a winch might conceivably automatically perform all the work done 
in England to-day.” (Ibid. p. 181 note). 

In other words the continual introduction of labor-saving devices might 
conceivably bring us some day to the point of being able to satisfy every 
conceivable desire merely by touching a button. Is that a "consummation 
devoutly to be wished?” Sismondi thinks not. With him the continued search 
for easier and bigger ways of doing things is placing the emphasis on the 
wrong place. A happier citizensy is what he wants, and the mere fact 
of greater production does not, to his mind, mean that happier citizenry. 

(2) The Orthodox Economists , Answer. —Sismondi was really dealing 
with a problem that we are forced to conclude was beyond his grasp. There 
can be no question, however, that the greatheartedness of his appeal did much 
to soften the cold-blooded attitude taken by early economists toward the 
introduction of labor-saving devices. As a result, it exerted an important 
influence in connection with the abandonment of the laissez faire attitude 


368 


THE EXPANSION OF ECONOMIC CONCEPTS 


toward the introduction of labor-saving devices. Economists are just as 
favorable today as ever to the introduction of these devices. In fact, their 
reasoning is somewhat more clear-cut and decisive than it has ever been 
before. It centers around two major lines, namely, (1) the scope of human 
desires, and (2) the bearing of labor-saving devices on employment. 

It is almost an axiom in economics that the scope of human desires is 
indefinitely great. That does not mean that man’s ability to satisfy those 
desires is not limited. It is thus limited, and it is because of that fact that 
value attaches to newer and easier ways of satisfying an increasing number 
of those desires developed by the cleverer intellects. If it were possible at this 
time, by the mere touching of a button, to satisfy every elementary desire 
which man now experiences, other unsatisfied desires would press themselves 
on us and it is even conceivable that civilized man would be laboring more 
eagerly and tenaciously to find an easier and better method of accomplish¬ 
ing ends that are at this time barely within the scope of our conscious 
longing. This fact is supplemened by the fact that each new process carries 
with it desires for things that would never have been felt without the de¬ 
velopment of the new process. To think that the introduction of labor- 
saving devices will ever bring humanity to a standstill because of its ability 
to satisfy every conceivable desire merely by the touching of a button, is 
indeed to think of an absurdity. 

The bearing of the introduction of labor-saving devices on the problem 
of unemployment calls for a somewhat more subtle analysis. This is true 
because there are so many contradictions in the face of clearly demonstrable 
truths. 

To say to the glass-blowers, for instance, that the introduction of a glass- 
blowing machine is beneficial to laboring classes is to state to them a glaring 
fallacy. And the glass-blowers are only one illustration among many. Persons 
who examine only the surface of this phenomenon even at times conclude 
that the great problem of unemployment is traceable to the increasing 
tendency to displace laborers with machines. These glaring contradictions in 
the face of evident truths make the theoretical aspects of the introduction 
of labor-saving devices somewhat difficult to present convincingly. 

There are, however, two oustanding arguments which have been ad¬ 
vanced with great assurance by the classical economists. They are: (1) Labor- 
saving devices lower the cost of living. As a result even though laborers do 
experience a reduction in wages, what they lose as producers they gain as 
consumers. (2) The increased output made possible by the mechanical in¬ 
ventions makes likely a lowering of prices, which in turn serves to increase 
sales. The increased demand for labor due to the enlarged output brings into 
the plant more laborers than are dismissed. A noted illustration of this 
phenomenon is that of the introduction of the linotype machine in the print 


POSSIBILITY OF A MORE EFFICIENT SYSTEM 


369 


shops. The great expansion of printing due to the quickened method of pro¬ 
duction has resulted in more men being employed in print shops since the 
invention than before. 

While these arguments are somewhat convincing from the standpoint 
of society as a whole yet they are far from satisfying to the individuals who 
may have lost their jobs because of the improved methods of production. 

Not very many of those inventions can be counted on to repeat the 
instance of the linotype machine. There will no doubt be an increase in 
demand, or purchases, accompanying the lowering of the price. But laborers 
may suffer in either of two ways. The absolute number may be reduced. In 
which case the compensatory action is hardly effective at all. Then again 
the laborers who are still employed may be lowered from skilled to unskilled 
workers, and thus encounter an actual reduction in wages. What most fre¬ 
quently happens is the employment of a few highly skilled men and the 
reduction of the rest to only semi-skilled and common laborers. 

It is necessary, therefore, for us to look further for a convincing and 
at the same time a satisfactory defence of labor-saving devices. The argu¬ 
ment seems to come with a full contemplation of the greatness of the order 
ushered in through the instrumentality of mechanical inventions. Without 
them the giant engineering projects which are the pride of our age would 
not have been possible. The very magnitude of these projects and the di¬ 
versity of talents called into service by them lead us to conclude that persons 
who cannot find a footing somewhere in the great variety of demands for 
labor brought into existence by these projects, and even places that net them 
rewards greater than previously received, are truly unfortunate persons. The 
fact that they do find those places and most frequently rise in the scale of 
compensation gives us reassurance in our faith in the great capitalistic regime 
in which we live. 

If, however, the consequences are as they are sometimes pictured by a 
poetical mind, that of the creation of massive capitalistic centers which, 
like great vortexes, are drawing into themselves the best blood of the race 
and swallowing it up forever, then the consequences of the capitalistic order 
must give us pause. Better had we adopt the hope of the American Indian 
that some day a great earthquake will destroy the white man with all his 
queer devices, after which the buffalo will return. A poetical symbolism, 
however, is not necessarily a scientific truth. Most of the unfortuiate conse¬ 
quences of the advent of capitalism are doubtless due to the newness of the 
thing. These may be expected to be eliminated as man learns better how to 
handle the great forces which he so recently has brought under his subjection. 

2. Forces Tending to Obstruct the Advance .— (1) The Limitation of 
Human Intellect .—If society should attack successfully the problem of re- 


370 


THE EXPANSION OF ECONOMIC CONCEPTS 


ducing the normal rate of interest on lucrative capital and if investment 
opportunities did not open for the successful employment of the loanable 
funds, the limitation of man’s own intellect would certainly be one of the 
causes obstructing the advance. We may ask, however, whether it would 
be wiser, as suggested by Professor Marshall, to expend the funds in pro¬ 
ducing those things which add merely to man’s comforts, or should attention 
not first be given to the production of those articles of great expense which 
are at times vital to human existence. Many millions of dollars could at this 
time be invested in the production of radium. With the lowering of the 
interest rate that great boon to humanity might at least be offered on the 
market by the ounce or kilogram instead of by the grain or gram. The fact 
that so many of the articles which are so badly neeeded are at this time so 
expensive leads us to wonder whether or not the human intellect will soon 
be puzzled to know how profitably to place the increased capital that might 
conceivably be made available at a declining rate of interest, resulting from 
a positive plan of lowering the interest rate. If the limitation of human 
intellect serves as an obstruction to the advance it will certainly be due to the 
fact that the better minds are not directing the disposition of the funds. 

(2) Obstructive Tactics of Established Interests .— (a) Labor’s Obstruc¬ 
tions .—We saw in connection with the effects of a declining normal rate of 
interest on lucrative capital that we might expect an encounter between the 
landed interests, the value of whose properties would be increased by the 
lower rate of interest, and investment institutions, whose very existence 
might be jeopardized. A corresponding encounter has already been experienced 
between labor groups and "captains of industry.” Laborers have almost con¬ 
sistently fought against the introduction of labor-saving devices. The fight, 
however, has been a losing one for the laborers. Yet at times and in certain 
communities, in final detriment to themselves, they have successfully op¬ 
posed the innovations. 

The reason why laborers cannot successfully oppose the introduction of 
labor-saving devices is the fact that they cannot make their opposition ef¬ 
fective over the whole field of industry. If their action is successful in one 
Community (or nation for that matter) the improvement will be made 
elsewhere. As a consequence of the saving made possible by the introduction 
of the labor-saving device in the other locality the article produced by it 
will come on the market in competition with those produced by the older 
and more expensive method. As a result the whole plant which has failed 
to introduce the improvement may be forced into bankruptcy. Labor groups, 
therefore, which have successfully opposed the improved methods of pro¬ 
duction may have kept their jobs temporarily at the expense of the particular 
enterprise in which they were employed. Wise business men have been aware 


POSSIBILITY OF A MORE EFFICIENT SYSTEM 


371 


of the danger and have most frequently successfully resisted the efforts of 
their men to push the pillars from beneath the very structure over their heads. 

Since we have demonstrated, to our satisfaction at least, that there is a 
net gain, in the end, both to the individual laborers and to society, to do all 
in our power to augment the supply of concrete capital goods, and since 
obstructive tactics on the part of isolated labor groups jeopardize the very 
existence of the enterprise for which the laborers work, we can only conclude 
that the opposition to labor-saving devices is a short-sighted policy. 

(b) Suppression of Patents .—Captains of industry have been on the 
whole more successful in their obstructive tactics than have the labor groups. 
It might seem that they would always be on the side of progress. Un¬ 
fortunately, however, that is not the case. Business men are usually eager 
to put in a labor-saving device if it lowers their expense of production. 
Being fully aware that if they don’t do so other producers will, and also 
hopeful of retaining in their own possession, for a time at least, some of 
the gains made possible by the savings, they are insistent On improvements in 
the plant. By and large, however, any particular manufacturer is as much 
at the mercy of competition as are the men in his employ. A new product 
may entirely destroy the value of a product already on the market. Desirous, 
therefore, of heading off changes which may cut under the demand for a 
good or service which any particular business man may be offering, he is 
just as likely to take action to head off the forces of change as are the men 
in his plant. With the great resources at his command the captain of industry 
can frequently attain a greater measure of success than can the labor interests. 

An important method of accomplishing this end is that of suppression 
of patents. Suppose, for instance, a new motive power should come into 
existence which would displace unquestionably and absolutely the gasoline 
engine. What action might we expect the combined automobile manufac¬ 
turers, oil interests, and other interests of the kind to take toward the 
change? If there was any possible chance of their once and for all destroying 
the ugly thing, would they not do it? Personally I doubt that they would 
even stop at so mild a remedy as the mere purchasing of the patent rights 
and suppressing them. They might even do as Rome did in the destruction 
of Carthage. 

Yet the order in which we live makes it possible for skillful promoters of 
new devices to win over the opposing interests. In an order of economic free¬ 
dom such as that of ours the law is on the side of the inventor. Let the in¬ 
novation be given publicity, and the tremendous pressure of the consuming 
public would soon come to the aid of the handicapped promoter. In the 
end the battle would be won on the side of progress. 

The fact is that we do make great headway in the direction of reducing 
the normal value of concrete capital goods. It is the supply of lucrative 


372 


THE EXPANSION OF ECONOMIC CONCEPTS 


capital—loanable funds—that serves to retard the movement possibly more 
than any other force. If society could once surely and positively develop 
a plan of reducing the normal rate of interest on lucrative capital a new era 
would dawn in the history of mankind. But even then we should be at the 
mercy of another great force—that of the law of diminishing returns. 

(3) The Operation of the Law of Dimrnis/jing Returns .—Exactly what 
bearing a falling interest rate might have on the law of diminishing returns, 
or vice versa, presents a problem of some difficulty. In its static aspects, 
however, it is somewhat easier to divine than it is in its dynamic aspects. 

According to the principle of proportionality the established institutions 
provide a correct amount of labor and of capital for the most effective— 
and in fact—the most profitable productive effort. With a declining rate 
of interest this equilibrium would be disturbed. The controlling reason why 
more capital cannot be employed is the fact that its yield in the productive 
process will be just enough to pay the established rate of interest. We may 
safely say, therefore, that a new position of balanced return would have 
to be established if the normal rate of interest should experience a decline. 

Since we are not finally convinced that, dynamically speaking, the law of 
diminishing returns is an actuality, we are not willing to admit that the 
increased possibilities opened up might not make available opportunities here¬ 
tofore undreamed of. For the time, however, the increased application of 
labor and capital might be expected to press harder and harder on the known 
methods of utilization of the natural agents. By the changing methods of 
utilization, however, man might, in conformity with the doctrine of Carey 
and Bastiat, find new methods of greater rather than smaller returns. If that 
could not be done in all instances, it might be done in some, and thus 
neutralize if not break the grip of that depressing law on human welfare. 
We can even hope, in this regard, that, in the absence of a social plan of 
regulation of the income from natural agents, the forces of progress would 
disintegrate those parasitical values. 

Better to understand the proposition here alluded to let us take the simple 
illustration of truck farming. It might be found, according to the current 
plan of operation, that $5,000 of equipment and ten hired men would bring 
in a net yield of $2,500 a year. From the income would have to be deducted, 
say, $200 for interest. Suppose, now, that $200 would pay interest on 
$20,000 instead of $5,000. What might the farmer not do with his farm? 
He could add all of the most advanced scientific devices, many of which 
were previously too expensive to be acquired. These new equipments might 
bring him in an extra $3,000 as well as his original $2,500. That fact would 
make it unnecessary that he buy more land in order to enlarge his income. 
Thus the pressure on land might be relieved and the value of land held down. 


POSSIBILITY OF A MORE EFFICIENT SYSTEM 


375 


The author is aware of the fact that the above illustration is built on 
an assumption of a constancy of the price of the product which arises as a 
consequence of increased production. As has often been stated in this study 
assumptions of that kind are necessary for the purpose of economic analysis- 
At any rate under an order of perfect adjustment to economic freedom any 
price that might occur would ultimately be realized in more wealth for alh 




John Baptiste Say ( 1767 - 1832 ) 

"He [Say] was born at Lyons on January 5, 1767. After a visit to England he entered the 
employment of an assurance company, and took part as a volunteer in the campaign of 1792. 
From 1794 to 1800 he edited a review entitled Decade philosophique, litteraire et politique, par 
une Societe de Republicains. He was nominated a member of the Tribunate in 1799. After the 
publication of his Traite, the First Consul, having failed to obtain a promise that the financial 
proposals outlined in the first edition would be eliminated in the second, dismissed him from 
the Tribunate, offering him the post of director of the Droits reunis as compensation. Say, 
who disapproved of the new regime, refused, and set up a cotton factory at Auchy-les-Hesdins, 
in the Pas-de-Calais. He realized his capital in 1813, returned to Paris, and in 1814 published 
a second edition of his treatise. In 1816 he delivered a course of lectures on political economy 

375 





























376 


THE EXPANSION OF ECONOMIC CONCEPTS 


at the Athene, probably the first course given in France. These lectures were published in 1817 
in the Catechisme d’Economie politique. In 1819 the Restoration Government appointed him 
to give a course on 'Industrial Economy* (the term 'Political Economy’ was too terrible). In 
1831 he was made Professor of Political Economy in the College de France. He died in 1832. 
His Cours complet d’Economie politique was published, in six volumes, in 1828-29.” (Gide and 
Rist: History of Economic Doctrines, p. 107 note). 

The following clipping from a eulogy of Say published soon after his death is not without 
significance: ''His private life was a model of domestic virtues. From the time when, with 
Chamfort and Ginguene, he founded the Decade Philosophique, the first work which attempted 
to revive literary and scientific pursuits during the storms of the French Revolution—alike 
when courted by Napoleon, and when persecuted by him (he was expelled from the Tribunat 
for presuming to have an independent opinion); unchanged equally during the sixteen years 
of the Bourbons, and the two of Louis Philippe—he passed unsullied through all the trials and 
temptations which have left a stain on every man of feeble virtue among his conspicuous con¬ 
temporaries. He kept aloof from public life, but was the friend and trusted adviser of some of 
the brightest ornaments; and few have contributed more, though in a private station, to keep 
alive in the hearts and in the contemplation of men, a lofty standard of public virtue.” (Quoted 
from the London Political Examiner of November 2 5, 1832, in the opening pages of the 
American edition of his treatise, published in 183 6). 

We could have as well placed the portrait of Say in connection with any 
one of several other subjects than that of the entrepreneur. It will be re¬ 
membered that Say did some excellent work in dealing with the subject of 
business crises. Likewise he pushed the concept of production far beyond 
that of most of his contemporaries. The fact, however, that he was the first 
to recognize the entrepreneur as an essential attribute to productive effort 
in its entirety remains possibly as his most distinctive contribution to 
economic theory. 

Since Francis A. Walker, an American, has the credit of bringing the con¬ 
cept clearly into English economic literature some may think us unpatriotic 
in not giving Walker the place here occupied by Say. We shall see later, 
however, that Walker made a more distinctive contribution to economic 
theory in connection with the theory of wages. 


CHAPTER VI. 


THE ENTREPRENEUR (ENTERPRISER) 

What Term to Employ. —We have chosen to head this chapter with 
the term Entrepreneur. Any one of at least nine other terms could almost as 
readily have been employed. Undertaker, which is the English of the French 
word entrepreneur. This is objectionable because of its unfortunate con¬ 
notation. Master, which is probably an earlier term than entrepreneur. This 
is really a hold-over from the middle ages. Captain of industry, which in 
many of its uses conveys the same idea as the word entrepreneur. It is, 
however, rather august for universal application. Manager, —although quite 
frequently used in the same sense as the word entrepreneur, yet its evident 
objection is the fact that managers are most often hired men. Employer, 
which is widely used in connection with labor problems but seldom elsewhere. 
Adventurer, which is one of the earliest English translations of the French 
entrepreneur but it connotes a daring not essential to the function here under 
examination. Business man, a term which if the author were left entirely 
free he would select as the most satisfactory of all. In well nigh every in¬ 
stance when merely a casual reference is made to the function here under 
consideration the term business man is employed. Proprietor, an old and 
familiar term but somewhat too narrow. 

We have placed the term Enterpriser in parenthesis beside that of Entre¬ 
preneur because it appears to be next in popularity in American treatises on 
economics. Yet we do not hold that term in high regard. It looks too much 
like an effort to discover a cheap substitute for the word undertaker, which 
has been dropped because of its unfortunate association with one particular 
business. If some day the word mortician finally crowds out of popular use 
the word undertaker as applied to that vocation, we may find it feasible 
and desirable to use the word undertaker in the sense in which we employ 
the French equivalent as the heading of the present chapter. We can see, 
however, that any one of as many as ten different terms could be fairly 
satisfactorily used. Any controversy over which of these should in fact be 
employed in treatises on economics must of necessity partake of the nature 
of a quibble. 


377 


378 


THE EXPANSION OF ECONOMIC CONCEPTS 


The Entrepreneur Function and the Social Order. —The entre¬ 
preneur function tends to be highly colored by the social atmosphere in which 
it operates. Under the laissez faire system it is far different from what it is 
under a system of positive governmental control of industry. Whatever the 
social order, however, the function has to be performed. It is a question of 
no small significance to discover under what social order the entrepreneur 
functions most satisfactorily to all concerned. We cannot make a close study 
of this last question. It will be helpful, however, to bring before our view the 
typical entrepreneur as he appeared during the different plans of social control 
of the nineteenth and early twentieth centuries. There are at least four of 
these. They are: (1) the relentless entrepreneur of laissez faire , (2) the 
benevolent entrepreneur of the mid-nineteenth century, (3) the militant 
entrepreneur of the late nineteenth and early twentieth centuries, and (4) 
the conciliatory entrepreneur of our own day. 

Under the laissez faire system we had probably the most genuinely typical 
entrepreneur of any period of economic history. All other factors of produc¬ 
tion were brought under his subjection and devoted to his purpose with 
utter disregard of other consequences than that of the direct objective of his 
own business project. Loyal to the teachings of Adam Smith and his immedi¬ 
ate successors, the entrepreneurs of that period considered that there were 
natural forces, independent of positive human agencies, that would spon¬ 
taneously work out in the end to the best interests of everybody. 

Possibly in the early years of the nineteenth century the consequences 
were not so terrifically bad. But as time passed and as the industries grew 
this attitude of utter indifference to consequences led to such glaring viola¬ 
tions of human sensibilities that even the entrepreneurs, themselves, experi- 
ened a change of heart. Men were kept on the job as much as eighteen hours 
a day. Women and children were ruthlessly employed at whatever tasks they 
could find. When we are apprised of the fact that even in coal mines women, 
nude to the waist, were like beasts of burden harnessed to underground 
trucks, we can only shudder at the extent to which some of those entrepre¬ 
neurs went on the assumption that in the natural order there were automatic 
adjustments between the individual and the social interest. 

Stung by the criticisms of Thomas Carlyle, touched by the appeals of 
Elizabeth Barrett Browning, chided by the experiments of Robert Owen,, 
and castigated by the logic of Sismondi, the entrepreneurs of the mid-nine¬ 
teenth century relented in their cold-blooded attitude toward their employees. 
We have at that time, therefore, ushered in the benevolent entrepreneurs. 
Thy followed the slogan that the employer owed- his men something more 
than his wages. As long as they were left to their own good intentions the 
entrepreneurs could not be counted on to do a great deal in the way of 
allowing the men something more than their wages. In fact the reforms 


THE ENTREPRENEUR 


379 


instituted in factories were not always as helpful as they may have appeared. 
Frequently the families of the employees were better housed, and the condi¬ 
tions within the plants were more wholesome than in the previous period, 
yet it is doubtful that the consequences were anything more than to give the 
employees a foothold on which to gird themselves for a determined struggle 
to better their own condition in disregard of the entrepreneurs’ favors. The 
fact is that even under a better planned plant and surroundings the workers 
were frequently taken advantage of by the truck system, and other under¬ 
handed methods of paying less than the contract wages. The laborers did not 
hesitate to show their resentment to treatment of this kind as soon as they 
were strongly enough organized to do so. 

During the closing years of the nineteenth century and the early years 
of the twentieth labor organizations became strong enough to call a halt 
to almost any policy developed by the entrepreneur in and of themselves. 
In some instances, notably the railway workers in England, the labor unions 
boasted of the fact that they allowed their employers only enough of the 
profits to keep them on the job. While not many labor unions dared to make 
such a boast as that, it became quite universally true that entrepreneurs felt 
the power of the labor unions and took steps to protect themselves from the 
dictation of their men. Many of the most wholesome conditions of employ¬ 
ment which are found today are here as a result of exactions made in labor 
codes. Fearful, however, that the organized laborers would become over¬ 
powering and make exactions beyond all possibility of compliance, during the 
early years of the twentieth century there developed the militant employer. 
Associations of employers were created for the definite and unconcealed 
although guarded purpose of protecting themselves from organized labor 
groups. From this time on men are treated as men, and, if you please, women 
begin to be treated as the equals of men. Organized laborers insist not only 
that conditions of employment be reasonably decent, but in addition that 
whatever the employers owe them be paid them in the form of wages. In 
other words the laborers themselves deny the assumption that the employer 
owes his men anything in addition to his wage. 

Through it all there begins to dawn a more enlightened attitude toward 
employment held both by the employer and by the men. We have chosen to 
call this period that of the conciliatory employer. Fearful that his men will 
join hands and make undue demands on him, the conciliatory employer 
attempts to anticipate those demands by establishing conditions of employ¬ 
ment somewhat better than he feels that his men are likely to demand. 
Organized labor, however, has not become so conciliatory. They fear that 
the men will again become mere pawns in the hands of their employers. In 
general, however, the employees are responding well to these conciliatory tac¬ 
tics. What the outcome will be cannot as yet be prophesied. 


380 


THE EXPANSION OF ECONOMIC CONCEPTS 


While the most characteristic aspects of the changing entrepreneur 
appeared in connection with the handling of labor, there are just as signifi¬ 
cant changes in other respects. We have only to follow the development of 
the one-price system to discover those changes in connection with general 
conditions of trading. Likewise the disappearance of the caveat emptor 
doctrine as a business policy in dealing with customers is another significant 
transformation. We have, therefore, a more conciliatory entrepreneur today 
than we have probably ever had before from whatever aspect we may con¬ 
sider the exercise of that function. 


Definition of the Entrepreneur. —By general consent the first 
economist to recognize the function of the entrepreneur was J. B. Say. 

“It may be remembered, that the occupation of adventurer [entrepreneur] is comprised 
in the second class of operations specified as necessary for the setting in motion of every class 
of industry whatever; that is to stay, the application of acquired knowledge to the creation of 
a product for human consumption. It will likewise be recollected that such application is 
equally necessary in agricultural, manufacturing, and commercial industry; that the labour 
of the farmer or cultivator on his own account, of the master-manufacturer and of the mer¬ 
chant, all come under this description; they are the adventurers in each department of industry 
respectively.” (Treatise on Political Economy, Book II, Chap. VII, p. 330). 

The fact that the translator employed the word adventurer for entrepre¬ 
neur is significant as a mark of the search for a suitable equivalent in Englfsh 
for the French term entrepreneur. 

After the writings of J. B. Say the entrepreneur concept was recognized 
throughout continental Europe. It was not clearly evident, however, in any 
treatise in English until the time of Francis A. Walker (1872). Walker, him¬ 
self, says that with the exception of his father he was unaware that any 
other economist had ever distinguished between the capitalist and the entre¬ 
preneur (Gide and Rist, p. 5 50 note). Walker, however, presented the case 
for the entrepreneur in a very vivid way: 

The highest type of them is composed of “those rarely-gifted persons who, in common 
phrase, seem to turn everything they touch into gold; whose commercial dealings have an air 
of magic; who have such an insight as almost to seem to have foresight; who are so resolute 
and firm in temper that apprehension and alarms and repeated shocks of disaster never cause 
them to relax their hold or change their course; who have such command over men that all 
with whom they have to do acquire vigor from the contact and work for them as they would 
not, perhaps could not work for others.” (Political Economy, p. 23 8). 

Yet owing to Walker’s peculiar interpretation of the entrepreneur’s 
return, which along with many other economists he called profits, he thought 
of the services of entrepreneurs as being graded from a no-profit class. The 
student will do well to read Walker further on this point. 

As the years have passed, however, the entrepreneur concept has received 
more and more careful attention by the economists until now we may safely 
say that every entrepreneur has imputed to him a reward for his services. That 
reward comes to him because of the fact that "he assumes responsibility in 
productive undertakings. If our analysis of economic factors has been under- 


THE ENTREPRENEUR 


381 


stood, little further exposition will be required at this point. The entrepreneur 
is not a laborer but an employer of labor; he is not a landlord, but a renter of 
land; he is not a capitalist, but a borrower of capital. He rents from the land¬ 
lord, borrows from the capitalist, and hires a body of laborers; and marshaling 
together the elements obtained from these, he institutes production.” (F. M. 
Taylor’s Principles of Economics, p. 84.) 

To understand more clearly what it is that the entrepreneur does that 
entitles him to separate treatment, we are forced to think in terms of a 
multiplicity of funcions rather than in terms of merely one function. The 
entrepreneur function may in fact be compared to a four-cylinder motor. 
It may operate without "hitting on all four” but the business will not be 
going smoothly. The four functions are: 

1. That of Invention. —The term invention is not so well chosen, for we 
mean by it something more than merely the invention of a new mechanical 
device. In fact most inventors in that sense of the word are very poor entre¬ 
preneurs. What the entrepreneur has to invent is new desires—or better, new 
ways of satisfying human wants. If he does not do that the products of 
his plant may pile up due to the lack of a market. The story of Andrew 
Carnegie and the creation of a new market for steel is appropos. He is even 
credited with having invented the reinforced concrete bridges, and other 
structures with the view of enlarging the market for the output of his steel 
mills. (See Marshall’s Industry and Trade, p. 222.) There are numerous other 
instances on record where entrepreneurs have in a similar way created new 
ventures and thus enriched the life of a whole community, state, or nation, 
at the same time that they were opening up a market for their own products. 

2. Coordination. —It is in connection with the matter of coordination 
that we find the entrepreneur marshaling the other factors in productive 
array. The failure to recognize the importance of coordination sometimes 
leads to strangely inaccurate conclusions. It is, for instance, sometimes said 
that since one hundred men can, together, do more work than can be done 
by one hundred men separately, each worker has the right to claim a share of 
the "surplus”. If it is remembered that the work of coordination has to be 
done by a force outside of the men themselves it immediately becomes evi¬ 
dent that there has to be a reward for the agency that does the coordinating. 
That agency is the entrepreneur. The only way that one could logically argue 
that the coordinating function is not entitled to a reward is that it can be 
expected to function without compensation. In many instances the very 
existence of the jobs for the hundred men comes as a result of the coordinat¬ 
ing effort of the entrepreneur. To say, however, that he always pays the 
laborers their due would be stating an evident fallacy. 

We have already noted that the coordinating function extends to the 


382 


THE EXPANSION OF ECONOMIC CONCEPTS 


other factors. Unless, therefore, the value of the product is enough more than- 
the cost of the labor, the other factors would have to go unrewarded also. 
So that the assumption that 100 men can together do more work than 100' 
men separately, encounters several contradictions. 

(3) Urbanization .—Just as we had to limit the use of the term inven¬ 
tion in its application to the entrepreneurs, so must we do with the word 
urbanization. The word urbane no doubt had its inception in connection 
with the city. But it has a meaning now of its own. It is this sense in which 
we are employing the term urbanization. Unless the function of smoothing 
out the rough spots, and polishing up the enterprise is done the business will 
not thrive. It may jog along like a motor which does not hit on all four 
cylinders, but it cannot gain full momentum. The entrepreneur is more likely 
to possess this quality than any of the others. The remarkable success of 
fraudulent promoters is sufficient evidence of that fact. 

(4) Risk Taking —So essential is the risk-taking function to the entre¬ 
preneur that in many instances this function is the only one attributed to 
him. Yet there are authorities who argue that the risk taking function affords 
no basis whatever for a claim for compensation. Reasoning of this kind 
grows out of the fact that in the long run losses and gains tend to neutral¬ 
ize one another. Thus there can be left no reward for the entrepreneur 
because of any assumption of risk on his part. This latter view, however, 
develops from the failure to distinguish the entrepreneur’s return from 
profits. When that distinction is made the risk-taking function can be pre¬ 
sented in a more accurate manner. 

The risk which the entrepreneur takes is not so much that of the uncer¬ 
tainties of business, but rather that his payment will come after all of the 
others are paid. If after all the losses and gains of industry are balanced 
against one another there does not remain a very real chance that there will 
be a sum large enough to make the business venture attractive to the entre¬ 
preneur he will not take the venture. He does, however, in effect, say to the 
rest of the participants that if anyone has to go lacking he will be the 
one. In that sense the entrepreneur assumes the risk of the business venture. 

It may be asked whether or not there is a single term which accurately 
describes the function of the entrepreneur. There certainly is. It is the term 
responsibility. On the shoulders of the entrepreneur rests the responsibility of 
the success or the failure of the business venture. It is hardly to be doubted 
that there are many persons who possess all the qualities of successful entre¬ 
preneurs who never make the venture for the very simple reason that they 
do not want to shoulder the responsibility necessary to become an entre¬ 
preneur. To say that a person is paid for assuming responsibility is not saying 
that he is paid for work. It is a burden that has to be carried, and so few 


THE ENTREPRENEUR 


383 


people are willing and able to carry the burden that those who do shoulder 
the responsibility can claim a reward for doing so. Once the responsibility 
has been assumed the entrepreneur functions in the manner which we have 
just described. 

Naming the Entrepreneur's Return. —1 . History of the Term 
Profits .—In the history of economic doctrines the term profits has been em¬ 
ployed in at least three distinct senses. Among the early classical economists— 
from Adam Smith to J. S. Mill—profits were thought of as applicable only to 
capital. "Profits on stock” was a favorite expression of Adam Smith’s. The 
term capital, however, very soon became substituted for stock. But the term 
profits was retained as expressing the reward that went to the capitalist. By 
close scrutiny, however, one can discover in the early writers that some¬ 
times the term profits relates to the phenomenon which we now know as 
interest, whereas at other times it signifies a return to the active capitalist. 
The active capitalist is really nothing more than an approximation to our 
concept of the entrepreneur. The concepts, however, are very much confused 
in early English authorities. Because of that fact we are not surprised to 
find almost nothing done by them in the direction of drawing a clear line of 
distinction between interest, profits, and entrepreneur’s returns. 

The second use of the term profits came when it was discovered that 
there should be a distinction made between interest on capital and returns 
to the entrepreneur. Even J. B. Say failed to discover that there should be 
any further refinement of the concept of the entrepreneur’s return than that 
of profits distinguished from interest. With him, and all of the other early 
authorities who recognized the entrepreneur, the term profits applied only 
to the entrepreneur’s return. Any amount that was left after the entrepre¬ 
neur had discharged all his business obligations to their mind belonged 
unquestionably to the entrepreneur. Based on that assumption F. A. Walker 
developed his characteristically decisive and clearly inaccurate analysis of 
the entrepreneur’s return. He along with the rest thought of it as profits, and 
thus he called it. Even to this day we can find reputable economists employ¬ 
ing the term profits much as it was employed by Say and Walker. Some of 
the most outstanding economists are guilty of that oversight. Among them 
are Professors Gide and Marshall, the economists whose works we have fol¬ 
lowed most loyally in this study. Yet the evidences are so easily discoverable 
that the term profits should apply to an income independent of the entrepre¬ 
neur’s return that we can only wonder at the persistence of the error. 

Beginning with Walras, however, there has been a gradual apprehension 
of the entrepreneur’s share as distinct from that of profits. As yet, however, 
a satisfactory term has not been found. That most frequently employed is 
wages of management. Sometimes we find business profits as distinguished 


THE EXPANSION OF ECONOMIC CONCEPTS 


3 84 

from pure profits, the latter applying to the accidental or ephemeral return. 

It was in connection with his effort to reduce economics to matters of 
mathematical equilibria that Walras was forced, by the very logic of his 
own plan of approach, to consider profits, along with rent, as a source of 
income over and above the expenses of production, and therefore a source of 
income over and above the entrepreneur’s return. It should be noted, however, 
that profits, as distinguishd from rent, under unrestrained competition tend 
to vanish, whereas under free competition the payment of rent becomes 
more certain. 

The distinction between profits and the entrepreneur’s return made by 
Walras (1874) has acted like leaven. Yet even when the very necessity 
of the recognition of the distinction forces itself on the writer, it frequently 
happens that he does not reduce his treatment of the subject to a clear and 
accurate analysis of a separate phenomenon. Some of the minor authorities 
have in fact done better work in handling the distinction between entrepre¬ 
neurs’ returns and profits than have the eminent scholars. As yet, however, 
the science of economics suffers from the lack of a satisfactory term to apply 
to the return that goes to the entrepreneur. 

Profits as such as distinguished from pure profits is highly confusing. In 
fact it is hard to see that any real distinction can be made between these two 
expressions. Yet no less an authority than that of Professor Gide designates 
the entrepreneur’s return as profits (as such) whereas he uses the expression 
pure profits to signify the less durable phenomenon. "Business profits,” a 
term frequently employed by Professor Taussig could as well apply to one 
as the other. Along with many other authorities, Professor Taussig tends to 
lump together both profits and legitimate entrepreneur’s return. 

When the expression wages of management is used as distinguished from 
profits there has usually been a clear distinction between the phenomena 
under consideration. Professor H. R. Seager handles the subject in that 
manner. There are, however, a number of reasons why wages of management 
is not satisfactory. In the first place the use of the word wages is unfortunate 
in that wages as such have to receive separate treatment in any satisfac¬ 
tory analysis of distribution. Thus far in the history of the science economists 
have been unable to explain wages except in the light of payments made by 
entrepreneurs. To call the entrepreneur’s return by the term wages, there¬ 
fore, is likely to lead to circular reasoning. Then again, managers are almost 
universally hired men. The very essence of the entrepreneur’s return is that 
of not being paid as a hired man. One may be a very excellent manager and 
a very poor entrepreneur. Likewise a man may possibly be a very excellent 
entrepreneur and not well qualified as a manager. His entrepreneurial ability 
will show itself in his selection of a good manager. We are thus forced to 


THE ENTREPRENEUR 


3 85 


the conclusion that the expression wages of management is far from a satis¬ 
factory one to employ. 

Since economics has no terminology it might be said that we should 
simply call it the entrepreneur’s return and let it go at that. When we say, 
however, that economics has no terminology what is meant is that the terms 
employed are terms which are already in use in common discourse. They are 
given in economics a special significance in that a closer view is taken of 
the thing referred to in ordinary discourse. The entrepreneur’s return is 
seldom, if ever, referred to as such in common discourse. The business man 
thinks and speaks of profits without really observing that there are invisible 
forces at work subdividing that which he is speaking of into two distinct 
phenomena. Economists are therefore somewhat more handicapped in select¬ 
ing a term here than elsewhere. It seems, therefore, that in this connection 
we are going to be forced to resort to the practice of other sciences and 
invent a term. 

What then is a good term to employ? We are going to suggest the word 
residuum. This we are doing in spite of the fact that Professor F. A. Walker 
spoke of the laborers as residual claimants. We have already shown that the 
entrepreneur is the residual claimant. His share comes only after all the rest 
have received theirs. His is really, therefore, a residuum. 

The Size of the Residuum. 1 . Seldom Found in Its Pure State .— 
(1) It may be mingled with wages. In spite of the fact that we must care¬ 
fully distinguish the entrepreneur’s return from wages, yet there is hardly 
any of the other shares in distribution with which it is as likely to be 
mingled as this. It becomes mingled with wages in two ways: (a) the entre¬ 
preneur himself may do work which might as well be done by hired men; 
(b) he may not pay the laborers their full wage and thus retain in his own 
hands part of the values which belong to his hired men. 

With regard to the first of these, there are some fields of operation in 
which, if the entrepreneur had to live merely on the residuum, he would not 
be able to live at all. In those enterprises, however, usually the responsibility 
for the success of the business side of the enterprise is not large. Yet the fact 
that the entrepreneur’s return is small may be due more to the absence of any 
great entrepreneurial ability than it is to the fact that the possibility of the 
return of some size does not exist. Many a person has worn his life away 
laboring at a task which if he had the full vision of a well-balanced entre¬ 
preneur he could more advantageously have hired someone else to do. Instances 
of this kind are many. Yet whenever such as that happens the entrepreneurs’s 
residuum becomes mingled with wages in such a way as to be well-nigh 
inseparable. It is due to this phenomenon that students of agricultural eco- 


386 


THE EXPANSION OF ECONOMIC CONCEPTS 


nomics are led to speak of the farmers’ income as their labor income. They 
really a mixture of wages and entrepreneur’s return. 

When the entrepreneur retains in his own hands portions of the income 
which should really go to the hired men he most likely does so because of 
some sort of handicap which the laborers are under in bargaining for 
their wages. The fact that entrepreneurs have not always paid laborers their 
full economic wages is clearly shown by the fact that when once the men 
have become strongly organized they have been able to secure increases in 
wages. The further fact that there is no sharp line of distinction between 
wages and the residuum has had the effect at times of making the entrepre¬ 
neur hesitate to grant and even refuse the just demands of his laborers. 
Similarly, laborers have, at times, made demands on entrepreneurs which, if 
they had been granted would have wrecked the enterprises. If we had a gauge 
which would enable us to discover exactly where wages stopped and the 
business man’s share began, many a serious industrial conflict could have been 
avoided. Although we cannot discover a clear dividing line, yet if we recog¬ 
nize that there are conomic laws which control both wages and the entre¬ 
preneur’s share and that they should be distinguished we have accomplished 
something. The recognition of the need of the distinction is half the battle 
in securing the subdivision. 

(2) It may be mingled with interest .—Just as the entrepreneur may 
work on his own job so likewise may he employ his own capital in his busi¬ 
ness. This may take the form of* lucrative capital or of capital goods. If 
lucrative capital, however, it will most likely be invested in concrete capital 
goods. Yet by putting a value on those goods and calculating an interest rate 
as a percentage on that value a deduction can be made from the income 
exactly as if the capital were borrowed. Capitalists, being very much wiser 
to their own interests than are laborers, and the charges for capital being so 
much more nearly uniform than wages, there seems to be very little occasion 
for very much of an error in separating interest on one’s own capital from 
the return which is due to the exercise of entrepreneurial ability. 

(3) It May be Mingled with Profits or with Kent .—We are treating 
profits and rent together here because they are both sources of income which 
is unearned. Whenever, however, the entrepreneur’s return is larger than he 
anticipated because of some happy coincidence which, in the course of time, 
may be expected to dissipate itself more or less automatically we may safely 
assume that the "residuum” is mingled with profits. Whenever an entrepre¬ 
neur receives a return above his expectation, or indeed above his legitimate 
share whether or not expected, which return is attributable to the ownership 
of a natural agent his income is partly rent. We need have little worry if 
the returns are swelled by profits for they will in time be eaten away by the 


THE ENTREPRENEUR 


387 


iorces of competition. But not so for rent. It may, therefore, become a 
question of great moment to find a way to separate rent from the legitimate 
-entrepreneur’s return. We may never do it with perfect accuracy. We may 
say, however, as we did in connection with wages that a recognition of the 
necessity of attempting to make the separation is a matter of no small con¬ 
cern. In some instances, however, the distinction may be easily recognized. 

2. The Pure Residuum Illustrated .—After the entrepreneur has made 
allowance for wages, interest, and rent, as well as the charges necessary to the 
efficiency of the plant, that which is left is composed only of profits and 
the entrepreneur’s share. If we can find a way to measure either of these 
remaining component parts the solution of the problem of the size of the 
other would of course be simple. Fortunately for us here, we do not have 
to measure profits. At least if we did measure them we should be meas¬ 
uring the results of pure chance. For the purpose, therefore, of arriving at a 
reasonable interpretation of the entrepreneur’s return we should proceed in 
disregard of the existence of profits. 

All that we need to do, therefore, is to consider what would be the 
characteristic of the entrepreneur’s return if production were carried on in 
a state of normal equilibrium. In that state no profits could exist. Entrepre¬ 
neurs’ returns, however, would exist, since there would still have to be 
organized businesses. To gain an accurate view of the entrepreneur’s return, 
therefore, we can do so only in our imagination. It would be the amount 
required to induce the entrepreneur to function in any one of the various 
business undertakings which would be operating in a state of normal 
•equilibrium. 

There is no reason to assume that any two entrepreneurs would of neces¬ 
sity receive the same return. At least only those entrepreneurs would receive 
the same who functioned in similar capacities. The problem, therefore, of 
finding an illustration of the pure residuum, if we are allowed to call it that, 
is that merely of examining the return to the entrepreneur in any capacity 
which he may happen to be operating in a state of normal equilibrium. If it 
were that of a contractor, say, we should expect his return to be equal 
as an entrepreneur to that which he would expect to receive in any capacity 
that he might work as a hired man. The illustration of a contractor is 
apropos, since, particularly in the carpenters’ trade, "journeymen” carpen¬ 
ters frequently become associated with certain contractors. They look to the 
contractor to find them work. Likewise the contractor depends on them to 
do his bidding. In the end he is not seriously disappointed if his net gain 
as a contractor is not more than the average of his best paid men. 

All that we can say from this is that the entrepreneur’s return and 
wages are determined in the same way. A plausible explanation of either 


388 


THE EXPANSION OF ECONOMIC CONCEPTS 


would furnish a plausible explanation of the other. Since we are not at this, 
point mainly concerned with distribution we shall have to wait until we 
reach the treatment of wages as such before we can attack analytically the 
economic laws here involved. 

The Entrepreneur and the Business Form. —The entrepreneur 
function is probably best thought of apart from any particular business 
form. Yet it cannot make itself felt without doing so through some kind of 
business form. It makes its appearance even in those businesses which have 
consciously attempted to eliminate the entrepreneur. 

When we think of the entrepreneur we almost involuntarily think of one 
who has conceived of and developed a business of one’s own. No doubt it has 
been in that way that the function has most frequently asserted itself. At 
this time, however, the single proprietorship has fallen to a secondary posi¬ 
tion as a business form. When a number of persons associate themselves 
together in business projects the question may well be asked whether or 
not the entrepreneur function does not become somewhat scattered or even 
dissipated. 

In answer to that question, however, we need only to recall that the 
entrepreneur function asserts itself in at least four ways. To find a single 
individual who possesses all of these qualities in a high degree is indeed diffi¬ 
cult. It is no doubt largely because of that fact that other business forms are 
crowding to the wall the single proprietorship. 

In the partnership it is a frequent occurrence that the different functions 
to be performed by the entrepreneur by common consent become allocated 
among the different partners. How often have we seen one partner devote 
practically all of his time in greeting people, and in a general way smoothing 
out misunderstandings created by other partners who are effectively giving 
attention to the other essential attributes of the entrepreneur function. 

In other business forms, such as the joint stock company and the cor¬ 
poration, the appearance of the entrepreneur function is not materially differ¬ 
ent from that of the partnership. Corporations are really administered in 
very much the same way as partnerships. A few of the outstanding men 
are chosen as directors. Among these directors the different aspects of the 
entrepreneur function will become allocated much as they do in the partner¬ 
ship. In many instances the indomitable spirit and great enthusiasm coupled 
with wise business vision of some one person will so completely dominate the 
organization as to make it function very much like a single proprietorship. 
At any rate there is nothing about the size and plan of the organization of 
a business to add difficulty to the comprehension of the entrepreneurial 
function. 


THE ENTREPRENEUR 


3 8? 

It is in connection with the cooperative plan of organization that the 
appearance of the enterpreneurial function presents something of an enigma. 
Yet when we remember that, after all, the returns which go to the entrepre¬ 
neur are measured very much as they are in the case of wages proper, the 
proposition becomes simplified. These organizations, however, do suffer from 
the lack of verve and zest that appear in businesses where profits are possible. 
The fact that entrepreneurs may at times receive something more than merely 
enough to keep them at their post is ever present in their mind when they are 
operating businesses for what can be made out of them. In the cooperative 
enterprises they know in advance that there is no legitimate chance to make 
more than a given salary. At times, however, there are persons who are at 
once embued with a desire for social betterment and endowed with the quali¬ 
ties of successful entrepreneurs. When men of that type connect up with 
cooperative enterprises these enterprises may be found to thrive in competi¬ 
tion with others led by men less socially minded. 


































































INDEX 


A 

Accidents, 32 5 

Advertising, 143-51 

Agriculture, the Department of, 146 

American Mercury, 154 

American Revolution, 4 

Anarchists, 8, 13-14 

Angell, Norman: Story of Money, 165 

Art, the Marketing of Works of, 145, 147-8 

Associative Socialists, 9 

B 

Balance of Trade, 4 
Bank Chains, 244-5 
Bank Correspondents, 244 
Banking and Business, Willis and Edwards, 
211-2 

Banks’ Relations to One Another, 240-5 
Banks’ Relation to the State, 245 ff. 

Barter, 15, 191 

Bastiat, Frederick, 92-3, 285, 365-6, 281 
Baudeau, the Abbe, 2 
Bazard, 163 

Beveridge Thesis, the, 172 
Bible of Socialism, 12 
Bimetallism, 203-6 

Blum: Labor Economics, 170, 171, 180 
Bohm-Bawerk, Eugen von, 60, 116 
Bonar, James, 22 
Bon Prix, 64-6 

Borrowers Relation to Banks, 23 8-10 

Browning, Elizabeth Barrett, 378 

Buccleuch, the Duke of, 22 

Buchanan, J., 22 

Bureau of Crop Estimates, 146 

Burns, Robert, 8 

Business Crises, 1 57-86, 263-4 

Business Cycles, 157 

Business Men’s Reactions to the Law of Com¬ 
petitive Price, 13 5-54 
Bye: Principles of Economics, 341 
Byron, Lord, 8 

c 

Cairnes, J. E., 317 

California Fruit Growers Exchange, 143 


Cambridge University, 3 9 
Cannan, Edwin, 22, 47, 50, 66, 338-9 
Capital as a Factor of Production, 3 33-57, 
341-6 

changing the supply of, 3 59 ff. 

classified, 3 5 5-7 

how formed, 346 ff. 

more effective creation of, 3 59-66 

theories of, 3 37 ff. 

Capital Turnover, 44 
Capital Values v. Capital Goods, 3 3 3-4 
Carey, H. C., 19, 281, 285-6, 365 
Carlyle, Thos., 11, 53, 378 
Cassel, Gustav, 126-7, 130, 177, 181-4, 209- 
11 

Caste v. Class, 316 

Catchings, Foster and, 54 

Catholic Socialists, 10 

Chain Banks, 344-6 

Changes in the Value of Money, 200-3 

Changing Normals, the Theory of, 9 5-9 

Chartism, 11 

Cheney: Industrial History of England, 313 

Chicago Board of Trade, 13 6-40 

Child Labor, 324-5 

Christian Socialists, 10-2 

Clark, J. B., 69 

Clark, W. L., 290 

Classical Economists, 3, 54, 56, 57, 1 13-4 
Classification of Economists, 19 
Classification of Credit Institutions, 23 5-6 
Clearing House Associations, 242-4 
Coal Miners, Condition of, 148 
Codes, Price, 13 8-9 
Coinage, 192 

Collective Bargaining, 145 
Commerce, Chambers of, 273-4 
Commerce Reports, 146 
Commercial Credit, 2 32-3 
Commercial Paper, 2 53 

Commodities not Adapted to the Exchanges, 
140-1 

Competitive Prices and Economic Progress, 
148-9 

Compromising Economists, 8 
Comte, August, 9, 56 
Condorcet, M. C., 51 


391 


392 


INDEX 


Constant Costs, 97 
Consumer Interest, 269 ff. 

Consumer Organizations, 274-6 
Consumers’ Surplus, 

Contract Labor, 315 
Cooperation, Consumer, 9, 272-3 
Cooperative Selling Agencies, 142-3 
Correlation Between Geld Production and 
the Price Level, 210 
Conventional Money, 215-6 
Cost of Production, Note on, 345-6 
Credit, 15, 22 5-64 

Characteristics of, 22 6-7 
Credit Circle, 227 
Credit, Definition of, 229 

Distinguished from Capital, 227 
Institutions of, 23 5-60 
Interest Rate and, 262 
Mill’s Treatment of, 22 8 If. 

Prices and, 262-3 
Value and, 260-2 

D 

Davenport, H. J., 30-1, 34 
Death Benefits, 32 5-6 
Decreasing Costs, 98 
Deductive Method, 14, 15 
Details of Government Assistance, 146-8 
Depositors in Banks, 23 6-8 
Diminishing Returns, 111-2, 283-7, 372-3 
"Dismal Science,” 11 
Distribution, Mill and, 59 
Physiocrats and, 41-6 
Division of Labor, 24, 47-8, 306 ff. 

Dominant and Contesting Theories of the 
Social Order, 1-20 

Dunbar: Theory and History of Banking, 
237 

E 

East India Company, 39, 108 
Economic Laws, 15, 41-62 
Economics as a Science, 5 8-62 
Edie: Money, Credit and Prices, 160 
Edinburgh, 21 

Efforts to Discover a Better Measure of 
Value, 203 ff. 

Edgeworth, F. Y., 209 
Eisenach Conference, 12 
Elasticity of Demand, 78-9 
Enterprises which Thrive on Price Changes, 
149-54 

Entrepreneur, 69-70, 377-89 
Ethics and Economics, 29 
Equation of Exchanges, 13 5-40 
Exchanges, Organized, 13 5-40 

F 

Factors of Production, 306 
Fair Price, 102-5 
Family, Types of, 10 


Federal Reserve Notes, 23 1, 2 52 ff. 

Federal Reserve System, 174, 247 ff. 

Fetter, F. A., 117-8, 150, 281-2, 287-9 
Feudal System, Emergence from, 217-9 
Fisher, Irving, 174-5, 187-8, 203, 208 
Forderungen, Rodbertus,’ 154 
Forests, 293-4 

Foster and Catchings, 168-9, 183 

Fostering Care of Producer Interests, 273-6 

Fourier, Charles, 9, 301-2, 312 

Free Trade, 50-1 

French Revolution, 26, 42, 46 

G 

Gambling not Productive, 3 5-6 
General Business Crises, 158 
Gide, Charles, 17, 33, 119, 120-1, 131, 174, 
192-3, 214-5, 226-7, 241-2, 261, 292, 
309, 337, 339-40, 353, 375-6 
Gide and Rist, 2, 7, 9, 11, 22, 40, 43-5, 46, 
48, 52, 53, 55, 60, 61-62, 69, 90, 93, 108, 
118, 131, 134, 156, 163, 165, 166, 167, 
197, 223-4, 302, 366-7, 304-5, 332, 356, 
363, 380 

Glasgow University, 21 

Godwin, ¥m., 51 

Gold Exchange Standard, 216-7 

Goods, Definition of, 110 

Gossen, H. H., 116 

Government Aid to Business, 144-6 

Gresham’s Law, 205, 207 

Griffin: Principles of Foreign Trade, 151 

Group Insurance, 226-7 

H 

Hamilton, Alexander, 19 
Hedging, 15 0-1 

High Price of Bullion, Ricardo’s, 198 

Hildebrand, Bruno, 12, 5 5 

Historical School, 8, 14-5, 54-8 

Hobson, J. A., 168 

Homan, Paul T., 86 

Homo Economicus, 54 

Hours of Labor, 32 5 

Hoxie, Robert F., 329 

Hume, David, 2 1 

I 

Increasing Costs, 34-5, 97 
Index Numbers, 203 

Individual v. Social Concepts of Wealth, 34-5 
Inductive Method, 14, 15, 54 
Industry and Trade, Marshalls’, 136 
Institutions of Commercial Credit, 2 56 ff. 
Intermediate Credit, 23 3, 2 56 ff. 

International Bimetallism, 20 5 
International Trade, 108 
Interstate Commerce Commission, 91, 102-5 
Investment Banking, 233, 257-8 
Irregularities of Demand and Supply Sched¬ 
ules, 79-80 


INDEX 


393 


J 

Jcvons, Stanley, 93, 116-7, 137 

K 

Kelley, Fred C., 153-4 
Kirkcaldy, 21 
Knies, Karl, 14, 5 5 

Knowledge of Rent and the Value of a 
Natural Agent, 297-9 

L 

Labor Coupons, 12 

Labor’s Cost of Production, 318 ff. 

Labor Defined, 304 
Labor Exchanges, 147, 321 
Labor Gradations, 315-7 

Labor, Historical Changes in the Status of, 
312 ff. 

Labor in the Productive Process, 3 03-3 0 
Labor Problems, 320 ff. 

Labor Saving Devices, 3 67-70 
Labor Theory of Value, 88-92 
Laissez-faire, 5, 7, 8, 13-4, 1 5, 44, 134, 145, 
161, 378 

Land and Other Natural Agents, 279,99, 
341-6 

Land Banks, 2 58 ff. 

Land Policy of the U. S., 290 
Land’s Part in Production, 2 80-2 
Laughlin, Prof. J. Lawrence, 209 
Laws of Labor, 308-12 
Laws of Wages, 308-9 
Legal Reserve Requirements, 274 ff. 

Lending Power of Banks, 242 
Le Play, F., 10 
Liberalism, 7 
Life Impulse, 20 

Limitation of the Number of Banks, 246-7 
List, Friedrich, 8, 19 

Longe’s Refutation of the Wage Fund Theory, 
316 

Lucrative v. Productive Capital ,3 34-5 

M 

MacWickar, J., 5 3 
Malthus, T. R., 39-40, 90 
Malthusian Law, 51-2 
Mandeville’s Fable of the Bees, 49 
Manipulation of the Market, 152-4 
Marcet, Mrs., 5 3 
Marginal Buyer and Seller, 80-3 
Marginalism, 69-70 
Marginal Productivity, 3 5 
Marginal Utility, 112-3, 130 ff. 

Market, Definition of, 70-1 
Market Value, 63-84 

Marshall, Alfred, 31-2, 77 ff., 85-6, 88, 93- 
102, 116, 129-38, 136, 171, 200-1, 206, 
275, 282-3, 285, 292, 318, 343, 363, 381. 


Martineau, Miss, 5 3 
Marxian Socialism, 12-3, 91, 178-9 
Marx, Karl, 12, 134, 167, 331-2 
Mathematical Economists, 171, 174-6 
McCulloch, J. R., 22, 90 
Measuring Price Changes, 201-3 
Menger, Karl, 15, 56-8, 116 
Mercantalism, 3, 5, 6, 7, 8, 23-4 
Mercantilist Concept of Money Overthrown, 
196-8 

Mill, J. S., 28-9, 53, 57, 59, 67, 92, 94, 107- 
8, 113-4, 116, 170-1, 174, 193, 207, 225, 
228, 261, 268, 3 10, 323, 337-41, 348 
Minimum Wage, 16 
Mirabeau, Marquis de, 43 
Mitchell, W. C., 1 5 7, 177, 183 
Mitchell’s Theory of Crises, 179-81 
Money, 189-222 
Money, Classified, 222 
Money, Definition, 189 
Money, Fiduciary, 189 
Money, History of^ 191-3 
Money, Marginal Utility of, 129-30 
Money, Representative, 193 
Monopoly Price, 74 
Moral Philosophy, 21 
Munera Pulveris, Ruskin’s, 11, 90 
Mystics, 10, 11 

N 

Naming the Entrepreneur’s Return, 3 83-5 
Napoleon, I, 26 
National Banking Act, 251 
National Biscuit Company, 149 
National Equitable Labor Exchange, 90, 16 5- 
6 

Nationalists, 19 
Natural Agents, 282-97 
Natural Order, 41-46, 64 
Neo-Classicals, 19, 60, 93, 171, 348 
Neo-Historicals, 19 
Net Product, 5, 42, 45, 279 
New Mexico Museum of Art, 147 
Nicholson, J. S., 22, 81 

o 

O’Fallon Case, 91 
Old Age Benefits, 32 5 
Over-Capitalization Theory of Business 
Crises, 172-4 

Owen, Robert, 9, 67, 90, 164, 378 
Oxford University, 21 

P 

Pareto, 2 87 

Patents, the Suppression of 371-2 
Periodicity of Business, 157 
Pessimists, 5 3 

Physiocrats, 2, 4, 23-4, 41-6, 66, 87 
Pigou Theory of Crises, 171-2 


394 


INDEX 


Population, the Malthusian Theory of, 40 
Positive Acts of Adjustment of Supply to 
Demand, 142-6 
Price Charts, 76-7 
Price Forecasting, 152 
Price Level, 159-60 
Prices, 48-9, 117-32 
Private Functions of Money, 194 ff. 

Private Ownership of Land, 290 ff. 

Producer Interest, Fostering Care of, 273 ff. 
Production, the Concept of 
Adam Smith and, 23-37 
Davenport and, 30-1 

Late English Classical Economists and, 27-9 

Marshall and, 31-2 

Mill and, 27-9 

Modern Revised, 29 

Say and, 23-4 

Surviving Confusion in, 32-7 
Taussig and, 31 

Professional Economists and Crises, 170-84 
Profits, the Term, 3 83-4 
Prohibition, 188 
Proprietors, French, 42 

Proportionality v. Diminishing Returns, 287- 
9 

Protective Tariffs, 46 
Proudhon, Pierre-Joseph, 22 3-4 
Psychological, 171 

■Purchasing Power of Money, Fisher’s 188 
Pyramiding of Credit, 263-4 

Q 

Quantity Theory of Money, 207-20 
Quesnay, Dr., 1-2 

R 

Radio Waves, 296-7 
Rae, John, 22 

Railroads, Valuation of, 102-5 

Raymond, Daniel, 19 

Rediscount, Institutions of 2 54 ff. 

References, 17-19 

Regulation of Bank Notes, 2 50 ff. 

Rent, 26, 297-9 
Representative Firm, 101, 3 54 
Representative Money, 193 
Residuum, 38 5-6 

Ricardo, David, 13, 52, 57, 67, 88-9, 92, 
108, 113, 277-8, 280, 347-8 
Ricardo, the Social Functions of Money and, 
197-9 

Rise of Laborers, etc., 3 27-3 0 

Road to Plenty, Foster and Catchings, 54 

Rodbertus and Industrial Planning, 166-8 

Rodbertus, Karl, 12, 1 3 3, 3 66-7 

Rogers, Thyroid, 22 

Roscher, William, 14, 5 5 

Rousseau, J. J., 39 


s 

Saint Simon, C. H., 9, 163 
Saint Simonians, 9-10. 

Saint Simonian Thesis, 163-4 
Saving, Theories of, 348-5 5 
Say, J. B., 26, 5 1, 88, 160-1, 170, 268, 375- 
6, 383 

Schmoller, Gustav, 15, 18 
Scientific Agriculture and the Ownership of 
Land, 293 

Scientific Method, 16-7 
Scientific Socialism, 12-3 
Scott on the Quantity Theory of Money, 
212-4 

Seager, H. R., 75, 1 14, 130, 195, 384 
Seignobos, Chas., Quotations from, 312-3 
Senior, N. W., 32 
Shelley, Percy, B., 8 

Sismondi, Jean Charles, 8, 67, 1 5 5-6, 161 
Sismondi’s Thesis Amplified, 163-70, 3 67-8 
Slavery, Emergency from, 312-4 
Smith, Adam, 4, 6, 7, 13, 21-2, 25, 44, 50, 
66-7, 88, 1 14, 157, 160 
Smith’s Challenge to Mercantilistic Concept 
of Money, 197 
Socialists, 8, 9-13, 133 
Spann: History of Economics, 22 5-6 
Special Business Crises, 158 
Speculative Credit, 23 3-5 
Special Interests, 267-76 
Specialties, 143 

Spontaneity, the Doctrine of, 6, 46-51, 347 

Stationary State, 347 

Stewart, Dugald, 22 

Stock Markets and Pools, 154 

Subsurface Rights, 29 5-6 

Supervision of Banks, 249 ff. 

Surplus, Consumers’, 81 
Surplus, Producers’, 82-3 
Surplus Value, 13, 3 55 
Symmetallism, 206-7 

T 

Tableau Economique, 2, 43-5, 8 8 

Taussig, F. W., 31, 163 

Taxes, 77-99 

Taylor, F. M., 381 

Tests of Productive Effort, 3 0-7 

Theories of Business Crises, 160-84 

Tolstoi, Count Leo, 11 

Toulouse, 22 

Townsend, Chas., 22 

Turgot, A. R. J., 26 

u 

Underconsumption Theory of Business Crises, 
161-70 

Unemployment, 1 1, 320-3 
Union, Labor, 144, 326 
Unity of Demand, 77 


INDEX 


39S 


Urban Lands, 294-5 

Utility, 25, 29, 110-11, 113-16 

U. S. Supreme Court, 91 

V 

0 

Value, Adam Smith and, 29 
Book, 109 
Exchange, 109 
In use, 109, 111 
Market, 63-84 
Normal, 87-105 
Price and, 67-9, 109-16 


w 

Wages, the Problem of, 323 
Wage, Minimum, 16 
Wages and Prices, (a chart), 164 
Walker, F. A., 32, 304-5, 376, 380 
Walras, Leon, 69, 116, 3 84 
Water Power, 296 

Wealth of Nations, 4, 6, 7, 22, 24-5, 307 
Wealth and Value, 32, 267-8 
Westerfield: Banking P. & P., 241-2, 262 
White’s Money and Banking, 164, 246 
Work v. Play, 310-11 


% 


i 

































